If you are new to the property development industry or you are looking to expand your knowledge, you are probably wondering what the tax implications of completing a property development project are to you and your business. Tax responsibilities can have a huge impact to your overall costs so it’s important that you know how tax is going to apply to you. Take a look here at our breakdown of the tax implications and what you need to know when developing a property project.
What are the tax implications of doing a property development project?
Tax implications for development projects are often extensive. When looking into how tax is going to impact you, it is important to understand the three main ways that a property development project may be taxed. Knowing how each of these income tax regimes produces different outcomes and the ways in which landowners may be able to reduce the amount of income tax payable when utilising the services of a good lawyer and tax specialist is an important part of any property development project.
There are three possible income tax outcomes that can apply to tax the proceeds from a property development project. These outcomes are:
Disposal of trading stock
According to the ATO, land that is acquired for the purposes of sale in the ordinary course of a property development or land trading business can be considered trading stock. This can also include a single acquisition of land by a developer. In addition, an increase in your trading stock’s value over the year is assessable income, while a decrease is an allowable deduction.
Land may also be considered as trading stock if it was not acquired for the purposes of sale in the ordinary course of a business, but is later held for this purpose. In this case the landowner is considered to have sold the land for either its cost or its market value before it becomes trading stock and to have reacquired it for the same amount.
Care always needs to be taken in making the valuation. If the landowner elects to use market value and that amount is more than the cost base of the land, then a capital gain amount occurs. Tax on the capital gain is payable regardless of the fact that the land has not been sold and no proceeds have been received. Despite this, in some cases it may be beneficial for the landowner to make a market value election to ensure that as much of the profit from the project is taxed under the capital gains tax provisions instead of the trading stock provisions. A capital loss arises if the cost base exceeds the market value.
Profit making scheme
In a profit making scheme, if you buy a property with the sole intention of developing and selling it for a profit, then your business is considered a profit-making scheme. Under this categorisation, any income earned from your property development is classified as your business’ income, rather than the sale of a single asset. Any income from the sale is taxed as ordinary income, on a revenue account, and the relevant marginal tax rate will apply. However, it is important to note that the application of these provisions may not always result in an optimal tax outcome for the landowner. Tax structuring involves taking steps to ensure that the landowner is not carrying on a business operation or commercial transaction.
In many cases, the application of this basis of assessment will turn on whether the landowner is carrying out a business operation or commercial transaction. Again this is a question of fact. If the profit is made in the course of carrying on a business, it is likely that the trading stock provisions will apply.
Capital gain under the capital gains tax provisions
Capital gains tax on property development is tax paid when you sell a capital asset. The cost base generally includes the acquisition cost of the land, certain incidental costs incurred by the landowner in acquiring or selling the land such as stamp duty and professional fees, capital expenditure on improvements and costs of owing the land such as interest on money to acquire the land. It’s worth noting that any capital gains made in a financial year are considered a part of your taxable income, so if you’re working or running a business all profits are pooled together to make your taxable income.
What are the key factors for determining tax treatment?
It’s imperative that individuals plan their tax strategy according to the category they fall into, or rather the best category they plan to fall into of they are at the beginning of their development project. Poorly planned and executed, the net tax position of a higher revenue scenario may be lower than the net tax position of low revenue scenario applied to the same parcel of land, depending on how the development is structured and undertaken.
In lay man’s terms, spending more money does not always result in making more money. Each individuals circumstances around the ownership, use and then disposal of land will be completely different, and must be assessed accordingly. Case law, legislation and tax bulletins state that the tax commissioner assesses each case by fact and degree to determine where the activity is assessed. Key considerations assessed are:
- Whether the land was initially acquired for profit making purposes
- The underlying intent (or lack thereof) of the taxpayer to make profit, or if this changed at some point (and when)
- If there are underlying, non-profit driven motives for selling the land
- The nature of the taxpayer’s day to day business or employment status
- The taxpayer’s prior experience in any subdivision or development activity
- The taxpayer’s association with or capacity to be influenced by other parties with experience in subdivision or development activity ( if advice is sought and when),
- If the activity is isolated in nature by the taxpayer
- The level of involvement of the taxpayer in the day to day running’s or management of the development (arms length can help extinguish enterprise treatment)
- The level of taxpayer-funded borrowings sought and secured for project delivery
- The level of taxpayer involvement in the disposal of the subdivided lots (marketing and/or vesting of depository power to other parties, arms length can help extinguish enterprise treatment)
- Magnitude and significance of works undertaken to realise the sites potential (ie, just enough to satisfy minimum council approval requirements or more)
- The absence or addition of dwelling construction to the activity (construction of dwellings typically triggering a view that enterprise is occurring).
- There is a change of purpose for which the land is held
- There is a level of development of the land beyond what is deemed necessary to secure relevant planning approvals for subdivision, and
- If dwellings have been erected on the land as part of the development activity
- Determining how your development activity will be assessed
How do these factors result in a specific tax treatment?
In determining tax treatment and what factors are putting you into a particular category, it is necessary to examine the facts and degree of each particular case. This may require a consideration of any number of the factors outlined above, or other relevant factors that the tax commission considers determinate in the case being assessed. These factors will need to be weighed up as part of the process of reaching an overall conclusion. Importantly, no single factor will be the determining factor. Rather, the entire case itself will be assessed altogether to determine an outcome.
Slight changes in the taxpayers intent, involvement, and experience can have significant consequences for classification of tax treatment. What you say or imply, when, and to whom are very important in the commissions assessment of facts and degree in a case of activity assessment. You need to comprehend that tax talk should be at the top of the list when considering selling, venturing or working with any developing party.
Establishing the Fact and Degree applicable case by case (or what the narrative should be prior to an audit by making a submission for a Private Binding Ruling (PBR) with the tax office) will be critical in determining which of the three tax treatments are applicable and what the best net tax outcome will be for the taxpayer. Smart taxpayers will realise that modelling different tax treatment scenarios should drive their level of involvement in the project and the development strategy, not the other way round.
Where properties are held as tenants in common, family trusts or individual ownership, it is entirely possible that taking the back seat and developing at arms length (ie. by entering into a development agreement with a professional developer) will have the activity assessed as a Profit Making Scheme. This can put the taxpayer in a better net tax position if they time the venture of their property into the profit making scheme well and they are able to apply CGT discounts to the initial period of ownership and discount this against the latter portion of value uplift from the development activity that is treated on revenue account.
The benefit of a taxpayer being assessed as having undertaken a profit making scheme needs to be carefully weighed up against selling the property as is (merely realising the asset) or transferring the property into a company and undertaking the project hands on without assistance (conduct of enterprise). Whilst transfer to and the conduct of enterprise under a company for the taxpayer would afford some recourse protection from development risk and a lower company tax rate, there would be the substantial added cost of transfer stamp duty and the foregoing of any CGT discount applications.
Get in touch with our team today
For more in-depth information about the tax implications of property developments projects, get in contact (https://costasconstructions.com.au/contact-us/) with our team today. Additionally, if you are looking for the perfect team to help you bring your vision to life, the team at Costas Construction can help you out. Get in contact with us experts now and see how we can take your development project to the next level.