Knocking down and rebuilding? Don’t fall for these tax traps
Julia Hartman
This is a scenario often seen in Australia’s suburbs. You take your valuable block of land with the old family home in the middle, split it in half, build a duplex and sell one side to cover the cost of building a newer, brighter family home.
However, as easy as it sounds (except for the act of demolishing and rebuilding), there are numerous tax implications and pitfalls to consider that the uninformed may notice.
There’s no escaping the fact that this is a for-profit venture. Going to the trouble of building a house to sell is a chore for GST and income tax purposes. There’s also no chance of it slipping through the cracks, as the buyer must retain the GST at checkout and remit it to the ATO.
You will get the same price for the home whether it is subject to GST or not. One in ten comes out of your pocket. If you are faced with this situation at the time of sale, you can insert a margin plan clause into the contract so that GST only applies to the difference between what you originally paid for that half of the property and the sales price.
The worst possible outcome is that the ATO turns up a few years later to call on the GST and it is too late for you to claim back the GST input credits for the margin scheme clause or on construction costs.
Now let’s get to the income tax consequences. There will be no principal residence exemption for as long as the land is located below your primary residence. It all depends on the side you give yourself.
You will be entitled to a 50 per cent CGT discount on profits from the date you purchase the property until the date the land is committed to duplex development.
There is a way to sell the other side of the duplex without charging GST.
But there is a problem here. On change of purpose you have the option to adjust the value of the land to market value or cost. There is no gain to declare in terms of cost, so there is no tax until the duplex is sold, but this also means that none of the prior capital gain on the land is covered by the 50 per cent CGT discount.
Obviously, you want this change of purpose to be at market value. This means you must declare capital gains in the income year in which you change purpose. Unfortunately, before you get the cash to pay CGT, you’ll lose any benefit from the 50 per cent CGT discount on any capital gains you’ve made since buying the property.
Given the tax implications and risks associated with construction, you may consider simply subdividing the block and selling the vacant land to finance your new home. Unless you purchased the property with the primary intention of subdividing and cutting off some of the land, this move can only be considered the realization of an asset.
Don’t be too business-like; Just do the minimum work required by the council and get an estate agent to organize the sale. Mere realization of an asset means that the gain remains within the 50 per cent CGT discount concession.
Regarding GST, don’t let anyone convince you to register for GST. You only need to register for GST if your turnover exceeds $75,000. The sale of a capital asset is not considered a turnover. But if you have registered for GST it is too late. Once you are registered for GST, the sale of vacant land will be subject to GST, even if it is a capital asset.
There is a way to sell the other side of the duplex without charging GST. This means keeping the property as a permanent rental for at least five years. If you can show that you actually built the other side to hold it as investment property, this will also keep the capital gains within the 50 per cent CGT relief concession.
Julia Hartman was founded BAN TACS Accountants Over 30 years ago and I am still passionate about all things tax.
- The advice given in this article is general in nature and is not intended to influence readers’ decisions about investments or financial products. They should always seek their own professional advice, taking into account their personal circumstances, before making any financial decisions.
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