© Property Professor articles — www.thepropertyprofessor.net.au.
Reproduced with permission.
So, you want to be a property developer. This can be a great way to make money, if you know what you’re doing. The property development process can be a long and complex one. The more you’ve planned and thought about your project, the more likely you are to succeed. Remember the old saying, “A failure to plan is just a plan to fail”.
In part ten of the Property Development 101 series, I outline some of the tax issues you need to be aware of when developing property.
Tax is a key issue when developing property. Smart developers will try and minimise their tax in a number of ways. Consulting with an accountant and setting up the correct ownership structures before you even buy the properties are just a couple of the initial actions you need to undertake.
Some of the major considerations so far as tax are concerned are:
- Capital Gains Tax (CGT)
- Income Tax
- Goods and Services Tax (GST)
- Margin Scheme
Capital Gains Tax or Income Tax
One of the first questions you need answered is, “Will the profit/income made from the development be considered as a capital gain or income?”. This is very important for a number of reasons but the main benefit of paying CGT instead of income tax is if you build and the rent the property for at least 12 months, you may qualify for the CGT discount of 50 per cent. In other words, you could halve your tax bill!
To help determine whether CGT or income tax will apply, it needs to be determined if you are “carrying on a business”. If the Australian Tax Office (ATO) deems you are, any profits you make on the sale of the property will be classed as income. So, what does “carrying on a business’ actually mean?
Carrying on a business
Whether you’re carrying on a business is a question of fact and degree. The following tests are applied:
Scale of operations – the larger the development(s), the more likely it is to be a business.
Your intention to make a profit – this seems odd as I don’t know anyone who develops property without the intention of making a profit!
How often you are developing – the more regularly you develop, the more likely you are to be deemed to be carrying on a business.
The amount of capital you have invested – the more money you invest, the more likely you are to be deemed to be carrying on a business.
Whether you’re keeping proper accounting records – this is similar to the intention to make a profit. Why wouldn’t you keep proper records?
Are you developing on a full-time or part-time basis – the more time you spend on developing the more likely you are to be deemed to be carrying on a business.
Level of skills and knowledge – if your skill level and knowledge is high, you are likely to be considered as running a business.
Does a business plan exist? – if one does exist, you’re more likely to be considered as running a business.
No matter how small a developer you are, you should meet the conditions in relation to making a profit and keeping records. How relevant the other criteria are to your development activities will determine if you are carrying on a business or not and whether you’ll need to pay income tax or CGT.
Basically, if you’re undertaking a one-off project, you probably won’t be considered to be a carrying on a business. However, if you’re doing this once every couple of years or more regularly, you’ll probably be considered as carrying on a business by the ATO. If this is the case, the entire profit will be liable to income tax rather than CGT and there’s no chance that you have the opportunity to halve your tax bill through the CGT discount. However, if it’s considered as income and you make a loss, this loss can be offset against other assessable income (but who wants to develop property and make a loss?).
Goods and Services Tax (GST)
In general, residential property investors don’t need to worry about the GST. However, if you’re a property developer, GST is a major consideration because unlike income tax or CGT, which is only payable if you make a profit, GST will need to be paid whether you make a profit or loss!
One of the first questions you’ll need to ask your accountant is if you have to register for GST. You’ll be required to register for GST if your annual turnover is more than $75,000 and you’re considered to be “carrying on an enterprise”. I don’t know many developments that cost less than $75,000 so just based on this, you should register for GST. However, not all developers are considered to be carrying on an enterprise.
Did you notice the difference in terms? To determine whether your profit was classed as income or capital gain, it needed to be determined whether you were carrying on a business. For GST purposes, it needs to be determined if you’re carrying on an enterprise. What the?!?
An enterprise is defined as an activity or activities done in the form of a business or in the form of an adventure or concern in the nature of trade. Confused? Let me explain with a couple of examples that the ATO provides on their website, www.ato.gov.au.
Astrid and Bruno live on a large suburban corner block. They decide to subdivide and cut off the backyard to allow Greta, their only child, to build a house in which to live. Astrid and Bruno pay for all the subdivision costs and Greta pays for the cost of the new house. This is viewed not to be an enterprise by the ATO.
Prakash and Indira have lived in the same house on a large block for many years. They decide to sell and move but want to maximise the sale proceeds. They decide to demolish their existing house, subdivide into two allotments, build a new house on each block and sell the new houses. This activity is an enterprise, according to the ATO.
Can you see a difference? For Astrid and Bruno it is more of a family venture whereas for Prakash and Indira it’s purely a money-making exercise.
The margin scheme is a method of calculating the GST payable on new property. The term ‘margin’ is basically the difference between the price you paid for the land and the sale price of the new dwellings. For example, if you paid $500,000 for the block of land, spent $500,000 on the development and sold it for $1.2 million, the margin is approximately $700,000 ($1,200,000 – $500,000). If you were registered for GST, your GST liability would be 1/11 of $700,000, which is approximately $63,600. In addition to this, you could claim GST credits on the development costs.
If you weren’t registered for GST, you run the risk of the ATO requesting the GST payment anyway and you may not be able to claim the GST credits.
This last article in the series has been one of my longest as tax is a very involved subject. I haven’t examined all the tax issues in detail as space does not permit me to do so.
If there are only two things you remember from this article, it should be this:
Find a good accountant that understands property development.
Consult your accountant, even before you buy the property.
By Peter “The Property Professor” Koulizos