Subdivisions, CGT and GST

Summary: When a block of land is subdivided, each unit will be taxed differently depending on whether the new units are sold immediately or held for a period of time to produce rental income.

Key take-out: Any new unit built on a newly subdivided block of land which is not the land-owner’s primary place of residence is not subject to the 50 per cent CGT discount.

Question: I am currently in the process of getting plans approved for demolition of my current Principal Place of Residence for a two-lot subdivision and construction. You mentioned in a previous article that "building two units with one to be sold and the other one to be lived in, would result in the carrying on of an enterprise." 
I'm not sure if that's what I will end up doing but if I did then - 

1. After I register for an ABN with GST how am I actually meant to apply it during the development process, should the property have been purchased through the ABN, and what happens now since it hasn't?
2. What about GST credits? In the above scenario could you only claim GST credits on half the costs since one of the units would be to live in? Or does that not matter as the overall project still had the intention to create some profit ie. "carrying on an enterprise"? 
3. Does that mean the sale of one of the units would require me to charge GST and therefore claim GST credits against it?
4. Would this sale create a CGT event and thus require CGT?
5. What happens if I end up selling the unit that I stayed in? Would this be liable for GST or be considered my PPR and be tax exempt?
6.  Lastly, I've seen on the ATO website something called a "Margin Scheme." It doesn't explain the scenarios when this can be used, could you explain about when and how it is to be used?  

Answer: I can’t find the original article to which you are referring, but I hopefully would have clarified the statement, “carrying on of an enterprise”, with this being the view of the ATO and not necessarily my own. You may find this difficult to believe, but the ATO has long had a habit of interpreting income tax legislation to maximise revenue collection rather than viewing it fairly, or in the way in which the legislators intended.

A simple example of this – although the ATO interpretation did not result in any extra tax collected but increased administration costs for SMSFs – was their previously stated policy relating to SMSFs using the segregation method. Under this policy, the ATO required that two bank accounts be kept – one for members in pension phase and the other for members in accumulation phase.

This was not formally required by the legislation, but the ATO stuck to this policy until it realised there were modern accounting systems which could keep track of the accounting required for members in accumulation phase and pension phase with only one bank account. The ATO now allows one bank account in such a situation.

Another example is the ATO’s unchanged policy requiring the trustees of a SMSF to change the name for all investments when a company is appointed to act as trustee from that of the individuals to the trustee company name.

When asked to justify this policy, the ATO could only point to the requirement for trustees to keep assets of the funds separate from personal assets, and the need for trustees to prepare an investment strategy. This means in fact there is no legal justification for the ATO’s policy requiring a change in the name of the trustee on all investments.

By trying to classify the subdivision of a main residence as an enterprise when one of the properties is being sold for profit, the ATO is attempting to classify the gain as ordinary income rather than as a capital gain. By placing this interpretation, and because the purchase date for land that is subdivided is the date of the purchase of the original block, the ATO wants to maximise revenue collection by not allowing the 50 per cent CGT discount when an asset has been owned for longer than 12 months.

With the above in mind, the answers to your questions are as follows:

1. As the property being subdivided was your main residence, GST would not have applied, and there is no requirement for you to backdate a GST registration. Therefore, you do not need to do anything else.
2. As you have registered for GST, you can claim input tax credits relating to the building costs for the unit which will become your profit-making enterprise. The entire project is not aimed toward making a profit, as one of the primary motives is to build a new home. Therefore, this part of the project is not caught up in the enterprise.
3. As you have applied for an ABN and regarded the other unit as an enterprise, that unit’s selling price would be subject to GST, which will equal one eleventh of the selling value, unless you use the margin scheme.
4. The profit you make on the sale of this unit would be classified as ordinary income as opposed to a capital gain. This means you will not be able to use the 50 per cent CGT general discount, and will therefore pay tax on the entire gain.
5. It would not matter when and if you sell the unit in which you live, as this will receive the main residence CGT exemption.
6. The margin scheme would apply to the unit you are building to sell. Under the margin scheme, when an asset is purchased without GST included in its purchase price – as would have been the case for your home – GST is payable on the difference between the original purchase price which didn’t include GST and the selling price.

If you wanted to maximise your net return after taking into account income tax and GST, you should consider renting out the unit for five years rather than selling it immediately. This would change the treatment of the unit from that of a profit-making enterprise to a rental property investment. Therefore, when the unit is sold, the 50 per cent CGT discount would apply.

The five-year timeline is because GST does not apply to a domestic residence that is more than five years old. Before taking any action in this area, you should seek professional advice.

If you have a question for Max Newnham please email it directly to max@taxbiz.com.au