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  • Tax consequences on sales of small scale land subdivisions

    Work out the income tax and GST consequences of subdivided land sales and if it's a capital gain or ordinary income.

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    Understanding land subdivisions

    When you undertake any subdivision of land that is not part of a property development business, even if it includes your family home, you need to understand when:

    • any gains or losses are treated as a gain or loss of income or capital
    • an activity is considered to be carrying on an enterprise for ABN and GST purposes.

    This is not applicable if you are involved in property development and purchased land in the course of your business.

    Income or capital

    Your purpose when you entered into an arrangement to purchase, develop or sell the land determines if gains or losses are a capital gain or ordinary income.

    Your purpose may:

    • occur several years after you acquired the land
    • change throughout your ownership period.

    The tax outcome depends on whether that disposal was:

    • a simple realisation of the property – the gain or loss is a capital gain or loss
    • a disposal undertaken as either part of a
      • business – the money received is assessable income of the business (see more about issues arising from being in a development business)
      • profit-making undertaking – the net profit is assessable income.
       

    It's likely that any gain will be a profit for income tax purposes and not merely a capital gain if your activities leading up to a sale look like:

    • a commercial transaction
    • part of an arrangement to make a profit beyond the appreciation in the value of the land only.

    If land is purchased as a capital asset, and there is a change in intention, the ultimate overall gain should be split between a capital gain and ordinary income.

    It is only the net profit you make from your profit-making undertaking that will be assessable as ordinary income.

    GST consequences

    You may have GST obligations and entitlements if you subdivide and sell land:

    • with the intention of making a profit
    • while carrying on a business
    • as part of a business or commercial transaction.

    Where the gain or loss on the sale of subdivided land is considered to be ordinary income for income tax purposes, the sale will be:

    Where the gain or loss on the sale is considered a capital gain, you may still have GST consequences on the sale if you:

    • used the land in an enterprise you were carrying on – the sale of the subdivided land will be a sale undertaken as part of that enterprise
    • are registered or required to be registered for GST – your sale may be subject to GST.

    If your gain or loss is capital because you merely realised the property value and did not use the land in an enterprise, your sale will generally not be subject to GST.

    If you are required to pay GST, you can claim a credit for any GST included in the price you pay for things you purchased to make the sale. You must be registered for GST to claim a credit.

    Factors to consider

    When you acquire the land as a home, farm or other capital asset, your purpose and the steps you take to sell the land determines whether the gain for income tax purposes is:

    • a capital gain
    • ordinary income from a profit-making undertaking.

    The following factors will help you work it out:

    This information is a guide only and provides additional detail in general terms for each of the factors in TR 92/3 Income tax: whether profits on isolated transactions are income.

    When considering the income tax and GST implications of your land subdivision, it is important to weigh all the factors together and not in isolation.

    The type of entity undertaking the subdivision

    To help determine if the land subdivision was commercial in nature and what the tax consequences are, consider the:

    • type of entity involved in your land subdivision
    • reasons for undertaking it.

    Regardless of your structure, you are more likely carrying on a commercial business deal when you:

    • engage a developer to carry out a development activity for a fee
    • share in the profits from the sales with the developer.

    More likely to be a capital gain if

    More likely to be ordinary income if

    • You are an individual and the subdivision and sale was driven by personal reasons. For example, a simple division and sale of part of land you no longer need.
    • You do not have a history as a developer.
    • If you own or control a business, it does not carry out any land dealing or development activities.
     
    • A business entity (such as a partnership, trust, company) is established, acquires property with the intention of making a profit and enters into a small-scale development.
     

    The types of activities you're involved in

    The types of activities you are involved in (not including the land subdivision in question) can help to determine if the subdivision was likely a part of a profit-making undertaking.

    More likely a capital gain if

    More likely ordinary income if

    • You are not engaged in business, or your business activities are not related to property development or property transactions.
    • You have not previously been involved in commercial property transactions or developments in any capacity.
    • You originally acquired the land primarily for investment purposes only, such as to earn rental income.
     
    • You have had previous commercial property transactions.
    • You operate a business related to property development, construction, or sale.
    • You originally acquired the land with an intention to undertake development activities.
     

    The costs incurred prior to the sale

    The costs incurred can help to determine if the land subdivision was commercial in nature.

    More likely a capital gain if

    More likely ordinary income if

    • The development cost is low compared to the value of the undeveloped land.
    • You were exposed to minimal financial risk in undertaking the activities leading to the sale.
     
    • The development cost is significant compared to the value of the undeveloped land. For example, attributable to building on the land.
    • You were exposed to significant financial risk in undertaking the activities leading to the sale. For example, mortgaging the land to finance the activity.
     

    The example below goes into detail regarding a one-off-profit making subdivision activity.

    Example: Claude’s one-off profit-making subdivision activity

    Claude purchased his home on a single title from a private seller on 1 July 2001 for $300,000. The house was situated on the front portion of an 800m² block. Claude wished to remain in this home however maintaining the big backyard became a burden.

    On 1 July 2020, Claude began detailed research and spoke with multiple local real estate agents to understand if he could subdivide his backyard to build a new house and sell it.

    Claude's registered valuer valued the entire property at $600,000 split 60%:40%:

    • original house and land – $360,000
    • newly created subdivided lot – $240,000.

    Claude decided to subdivide, build a house, and sell the newly created subdivided development. To do this, he:

    • lodged an application for subdivision and received council approval
    • engaged a project developer to:
      • prepare and submit a development application
      • build the new house.
       

    Claude funded the development expenses of $440,000 (GST inclusive) through a bank loan and expected the sale of the new house to pay the loan out in full.

    He engaged a local real estate agent to sell the new house. He sold it via a contract signed on 1 July 2021 for $1,210,000. There is no agreement to apply the margin scheme to the sale.

    Income tax outcome

    Once the backyard got its own title, it became its own asset and was no longer part of Claude’s home as a domestic asset. Because Claude's transaction is more complex than just selling the vacant lot, his activities amount to a development activity.

    The sale of the backyard became a profit-making activity once Claude made the decision to embark on that activity. The net profit from that activity will be included in his assessable income:

    • Claude made an overall gain (net profit plus capital gain) of $580,000. This will be the assessable income he pays tax on.
    • The overall gain ($580,000) is based on the GST exclusive sale proceeds ($1,100,000) minus the GST exclusive development expenses ($400,000) and the original cost attributable to the newly subdivided lot of $120,000($300,000 x 40%).
    • The increase in the value of the newly created subdivided lot from when it was originally acquired (1 July 2001) up to when the profit-making activities began (1 July 2020) should be treated as a capital gain.
    • The original cost, attributable to the newly created subdivided lot was $120,000 (40% of $300,000) on 1 July 2001.
    • The value of the newly created subdivided lot at the time Claude began to undertake profit-making activities on 1 July 2020 was $240,000. As Claude has held the subdivided block for greater than 12 months he is entitled to a 50% CGT discount, hence there is a discounted capital gain of $60,000.
    • The increase in the value of the newly created subdivided lot from when the profit-making activities began up to the time of sale should be treated as ordinary income.
    • The net profit ($460,000) will be based on the GST exclusive sale proceeds ($1,100,000) minus the GST exclusive development expenses ($400,000) and the value of the subdivided lot ($240,000).

    GST outcome

    As Claude has entered a profit-making activity and the projected sale price of the developed land will exceed the GST registration turnover threshold, he is required to register for GST. He will:

    • have a GST liability of $110,000 on the sale price of the townhouse
    • provide a notification to the purchaser of the amount at settlement to be withheld and paid to the ATO
    • be able to claim $40,000 credits for the GST included in the price of his development purchases (subject to the normal GST rules)
    • report these transactions by completing business activity statements.
    End of example

    The complexity and steps undertaken

    The complexity and steps undertaken to prepare the land for sale can help to determine if the subdivision was commercial in nature.

    More likely a capital gain if

    More likely ordinary income if

    • The land sale involved
      • a single transaction
      • the sale of an unimproved block.
       
    • The cost of development is low compared to the value of the undeveloped land.
     
    • The land was purchased for the purpose of subdivision and sale. An indication of this is if you sought approvals soon after the land was acquired.
    • The land sale involved significant improvements. For example, to improve its condition to maximise profit, or the construction of houses, other buildings, roads or other community services to individual lots.
    • The overall project involved the purchase and development of neighbouring blocks.
    • The subdivision was subject to a decision by a government authority to rezone the land, that you or related parties lobbied for.
    • The costs of development are significant compared to the value of the undeveloped land.
     

    The parties and phases involved

    The sale of your land subdivision is more likely to be considered commercial in nature and treated as ordinary income when:

    • it occurred in phases over a period of time
    • multiple parties were involved
    • it required a series of transactions between various parties (such as professional agents and advisors) to enable the sale of the property.

    More likely a capital gain if

    More likely ordinary income if

    • It is a straightforward one-off transaction between you and a purchaser.
    • The only element of the arrangement is an agreement to transact and sell land in its existing state.
    • There are no other parties involved in finalising the sale (except for real estate agents and conveyancers).
    • If you were approached by a third party to facilitate a sale, rather than actively marketing the property.
     
    • You transacted with multiple parties (such as architects, property developers and consultants) through various agreements to prepare the land subdivision for eventual sale.
    • The sale relied on a number of additional steps and was significantly more complex than a standard residential sale.
    • Engage a developer to carry out a development activity for a fee.
     

    Your relationship to other parties involved in the land subdivision

    Your relationship with others involved in the land subdivision and sale can help to determine if the land subdivision is commercial in nature and treated as ordinary income.

    More likely a capital gain if

    More likely ordinary income if

    • Type of parties involved were limited to those such as real estate agents, conveyancers and surveyors.
    • The arrangement is non-commercial and more in the nature of a family dealing (such as selling a granny flat previously used by a family member).
     
    • Where professional third-party experts (such as architects, developers and consultants) act on your instructions, their business activities are taken to be your activities.
     

    Your purpose in buying the land

    The purpose for entering an arrangement to develop and sell land may occur several years after the land was acquired. The purpose may change throughout the ownership period.

    If you purchased the land for sale and did not use it for any other purpose, the transaction was commercial in nature and ordinary income.

    More likely to be a capital gain if

    More likely to be ordinary income if

    • The land was purchased
      • exclusively for private purposes, such as your family home or holiday home, and was held for a significant period
      • as a rental investment property that was held for a significant period
      • as a farm for the purpose of farming activities.
       
     
    • The land was purchased:
      • to be developed
      • for land banking (holding for future development).
       
     

    The example below demonstrates entering a mixed purpose development arrangement to rent and sell land.

    Example: residential suburban block development

    Mr and Mrs Block purchased a house to live in on a large block of land in 2000. In 2017, they applied to subdivide the land for development. They planned to demolish the house and build 3 townhouses:

    • one townhouse for Mr and Mrs Block to live in
    • one townhouse to rent out
    • a third townhouse to be sold at a profit.

    They hired an architect to design the townhouses. They engaged a developer to obtain the permit and subdivide the land. They funded the development using a bank loan and the property was used as security. The loan application and finance terms supported this.

    The townhouses were completed in late 2018. Mr and Mrs Block planned to move into one townhouse. They hired a real estate agent to rent the second townhouse and sell the third.

    However, an unexpected change in their circumstances occurred. Mr Block fell ill and had to move into a nursing home. Following their financial planner's written advice, they funded this move by selling all 3 townhouses in early 2019, making a substantial profit.

    Income tax outcome

    • The land subdivision and sale is not carrying on a business.
    • The gain from the sale of the townhouse built to sell is ordinary income, from a profit-making undertaking or scheme.
    • The gain from the 2 townhouses not built to sell is not part of a profit-making undertaking and is the realisation of the capital value of those assets.

    GST outcome

    Mr and Mrs Block’s original intention for the townhouses included:

    • a private purpose for the townhouse intended to be their home – not subject to GST
    • making input taxed supplies (residential rent) for the townhouse intended to be a rental property
    • sale (a taxable supply) for the townhouse intended for sale.

    The couple were carrying on a development enterprise and were intending to start a leasing enterprise.

    They are required to register as a partnership for GST. They would meet the turnover test and:

    • the sale of the townhouses built to rent and sell will be taxable supplies as they will be made as part of their enterprises
    • they are entitled to GST credits for construction costs of the townhouse built to sell
    • they are not entitled to GST credits for construction costs of the other 2 townhouses
    • they are entitled to an adjustment to claim GST credits for the taxable supply of the townhouse intended for rent.
    End of example

    The timing and steps undertaken for the sale

    The length of time you own the land can help to determine if the land subdivision is commercial in nature and treated as ordinary income.

    More likely a capital gain if

    More likely ordinary income if

    • The land is owned for a significant period and used, for example, as a house or farm. This is evidence you acquired the land for those purposes.
     
    • The land was owned for a short period before being sold.
     

    Evidence you need to determine intent and purpose

    Even when a land subdivision involves your family home, you need to keep evidence of the subdivision process.

    Written records are the best evidence of your purpose and intention and are much more valuable than what you can remember in hindsight.

    Further assistance

    This information provides general examples that illustrate principles described in:

    If your circumstances are not fully covered here or you are unsure how it applies to you, contact us or seek professional advice.

    For how to seek a private ruling, see Land subdivision – supporting information.

    Last modified: 18 Jan 2023QC 71028