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Tax advantages from the right property development structures

Feb 09, 2018
Tax advantages from the right property development structures

A break even property development can still lose money. Property development structures can make or break a project.

Sadly taxation law does not follow common sense. Common sense would say that if you had a house in Perth, and you spend an extra $700k developing it; and you generate an extra $700k in sales from the project you have broken even.
This is not the case. Depending on how the project is structured the tax outcomes of the development can vary widely.

The family home
If you sell the family home you can do so tax free (s 118-110 97 Tax Act).
The concept is simple however, sadly, it is also one of the most complex provisions in tax law.
You can only have one family home. So if you own a home, and you subdivide the back block, you no longer have one family home. You have the front home and a vacant block of land.

The vacant block of land (with trees and the like on it) cannot be your main residence. As it does not have a “dwelling” on it the land is now taxable.

For example
John buys a 580sqm house in Morley in 1990 for $175k.
The home is now work $650k. John incurs $30k in fees and then subdivides the back block (280sqm).
John sells the back block for $300k and the front block with the home for $400k.
Now in this instance John has made a measily $20k profit from the development. However taxation law will say that the back block cost John (say) $85,000. He incurs a share of the $30k subdivision costs (say $10). So his total costs is now $95k.
John has sold his asset for $300k so he has a prima facie profit of $205k. And the tax liability on that deal will potentially be around $47k (a few ways to get this down that we will not discuss here).
The deal, that seemed like a minor profit, is now a decent loss simply because the tax position has not been considered.

Development projects
Further, the build of a new home is a significant undertaking. And from a taxation perspective that significant undertaking is a business.
So GST will apply.
If you are liable for GST the sale proceeds from the deal can be 10% of the sale. And there are ways of reducing that liability through a system called the margin scheme – provided your tax professionals have altered the purchase and sale contract to deal with the margin scheme.

For example
John buys a 580sqm house in Morley in 1990 for $175k.
The home is now work $650k. John incurs $60k in fees, demolishes the house, and then builds a home on the front block (300sqm) and a home on the back block (280sqm).
John sells the back home for $600k and the front home with the for $650k with a construction cost of $600k.
On the face of it – the GST payable on the sale will be $113k. So the profit, again, becomes a loss.
However the application of the margin scheme, if considered properly, will considerably reduce this liability.

Splitting the assets up
If a person does a joint venture with another the process sounds simple. In effect the parties go in together complete the project and then everything is sold.
However sometimes the project is not sold. The properties are “divvied up” among the investors.

For example
John and Sarah (work mates) buy a duplex in Scarborough for $800k.

They spend $800k on the development. Each unit is worth $1m each.

John takes a $1m unit and Sarah sells her $1m unit.

In this case both parties own 50% of the total land. So if John takes a unit he is actually buying Sarah’s part of the unit. And stamp duty will apply to that sale.

Likewise, if Sarah is selling her unit – she is selling part of John’s share as well.

So not only is John paying stamp duty on acquiring his interest from Sarah he will also pay income tax on the sale of his share of Sarah’s unit.
In this situation a document called “a deed of partition” can be created. This document will iscolate each person’s interest in the land and can avoid the woeful tax outcome detailed above.
However this document must be done in advance of the land going to State Revenue for stamp tax assessing.

Key take-away
A business family who does property development is dealing with large amounts of money. And the tax structuring of a development will be a key driver of the net after tax cash returns payable to the family (for either re-investment or funding use). And cashflow forecast must take into account the tax liability and must be prepared by a tax professional who is committed to making family owned businesses great – in this case property developers.

At Westcourt one of our key competitive advantages is our superior tax knowledge. With our representation on technical tax committees reporting to government at the highest level we are intimately aware of the opportunities available for property developers of this like. And our ability to integrate the family business dynamics and complexities gives us an insight into these activities that few others can identify.

A tax plan, together with an integrated cash flow forecast for your next development will significantly reduce your future liabilities and help your family business become great.



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