Property Development – Tax Issues to Consider
Property development could it be just a “mere realisation of an asset”?
A “mere realisation of an asset” implies that the profits made are subject to capital gains tax with the benefit of the 50% discount, whereas otherwise would be seen as an enterprise, and subject to tax as ordinary income, at the owners full marginal tax rate.
A recent Private Binding Ruling issued by the Commissioner of Taxation has shed some light towards their interpretation of property developments and their classification. Specifically, the ruling highlights a point of difference between whether income is ordinary income or capital gains.
In the ruling, the taxpayer’s had owned a large rural property for many years. In that time, they had constructed a principal residence, operated a small farming business and had split the land to build a second residence for family members.
After a mine subsidence compensation claim was made by the owners, the primary production business stopped. Later, the land was re-zoned by the council allowing the subdivision of one acre blocks.
After this sequence of events, the owners decided to contract a developer to undertake a substantial subdivision project. Under the project, the developer would undertake all the activities over a period of time from initial commencement to settlement with contracted purchasers. Importantly, the developer was going to undertake the Development Application, after such time as surveying and land designs were completed.
From these facts, the ATO was asked to rule on what classification of income was appropriate. Namely, whether the profit was:
- • ordinary income from carrying on a business of property development
- • ordinary income as a result of an “isolated transaction” carried out for profit, or
- • Statutory income under the capital gains tax provisions.
The decision ultimately was that the sale of land was a capital gain. As the developer would undertake all of the activities associated with the development, there is an adequate separation of control that deems the proceeds to be a mere realisation of an asset.
Paragraph 6 of Taxation Ruling TR 92/3 outlines that profit from an isolated transaction will depend on circumstances such as whether:
- (a) the intention or purpose of entering into the transaction was to make a profit, and
- (b) The profit was made in the course of carrying on a business or commercial transaction.
Alternatively, it can easily be argued that the taxpayers entered into the transaction once the mine subsidence and council re-zoning took place. Therefore, to knock down the property, subdivide and sell (via an intermediary) was intended to make a commercial profit after a significant change from a hobby farm primary residence.
However, the Commissioner has essentially ruled that, in totality, the taxpayer’s intention when they entered into the transaction was for a main residence. #
A significant factor for the decision to subdivide (or develop) the land was due to a council re-zoning. While this wasn’t the only factor, it was nevertheless a decision outside the taxpayer’s control.
An opportunity exists for landowners whose property has changed significantly on re-zoning. It can be argued that, in this instance, the taxpayers took advantage of a change in governmental policy for the mere realisation of an asset. Many lands, especially in capital cities, may have recently changed purpose due to re-zoning, and an argument may exist to say that property developments in these instances are on capital account, rather than on revenue.
#where the profit-making transaction involves the sale of property, it is usually, but not always, necessary that the purpose of profit-making exist at the time of acquiring the property.
Points to Consider
- Land holdings if sold as is, would in many cases be exempted from any tax payable under various exemptions for principal place, or farm land. However the sale may not realise the full potential value of the land that a developer could exploit.
- However if the land had been owned for a period of time, with no original intention to subdivide, opportunities could arise to benefit from the ATO treating the subdivision as a capital event rather than ordinary income.
- The fact the land owner, tried to distant themselves from the development work, by engaging a developer, appeared to allow the ATO to see the development as an opportunity to merely realise the best value for the land on a capital account.
- Many such developments are sold to a developer with or without a DA.
- Regardless how the development is conducted, there is significant accounting, apportionment, GST Margin Scheme issues to be considered separately on the sale of new residential land to the ultimate home owners.
Copyright CCH & Garry Wolnarek