Generally, in Australia, you are not taxed on gains from the sale of your home (including up to 2 hectares of adjoining land) because of the ‘main residence exemption’ within the Capital Gains Tax (‘CGT’) law.
However, when you subdivide the land on which your main residence stands, you can trigger unforeseen tax liabilities.
A. Main Residence Exemption
Let’s assume that there is little doubt that the residence as it stands is your main residence and would qualify for the main residence exemption from CGT. You have bought a house, lived in it, have not rented it out, you did not live away from it for any long period of time, and you have not claimed any other property as your main residence during the period of ownership.
If you had have just sold that house, the capital gain would be exempt because of the main residence exemption.
1. Main Residence Exemption lost on new assets
You can only claim the CGT ‘main residence exemption’ for a dwelling that you have actually lived in.
If you choose to subdivide and create a vacant lot and/or build a dwelling on the newly created subdivided lot, that lot or the other dwelling will not qualify for the main residence exemption, and you’ll end up paying tax on any profit made on the sale.
2. Demolition of Main Residence
Because you can’t live in your main residence after it's been demolished, you run the risk of the main residence exemption not applying.
There is a way to maintain the full exemption:
You must have been eligible for the full main residence exemption on the original dwelling when it was demolished.
The replacement dwelling on the land must become your new residence as soon as possible once completed.
It must continue to be where you live until you sell it.
The new dwelling must be your main residence for at least a period of 3 months after you move in.
You must “treat the vacant land and new dwelling as your main residence for the period starting when you stopped occupying the previous dwelling and ending when the new dwelling becomes your main residence, and this period is 4 years or less” - i.e.: not claim any other property as your main residence.
To maintain the full exemption, when you come to sell the land, you dispose of both the new house and the land at the same time.
3. New Asset created
Each subdivided block constitutes a new asset for CGT purposes.
The original cost base of the main residence and its land is apportioned between those new assets on a “reasonable basis” – which can be quite complicated to determine.
4. Immediate sales
If you do sell the new blocks immediately after subdivision, or at the same time as your existing main residence, then you would be able to qualify for the 50% CGT discount on the net profits if you have held the properties for more than 12 months.
5. Business or ‘profit-making schemes’
Certain property developments will be considered a ‘mere realisation’ of property and remain on capital account if the development involves only the bare minimum work required to comply with council requirements – e.g.: construction of service roads, connection of essential services.
However, if the development goes any further from the bare minimum and moves into the construction of new buildings or residences, then such developments will likely be treated as an isolated profit-making scheme.
6. Sale of demolished site as a Capital transaction
The land’s cost base will be based on the historical cost of the land only and not the part of the purchase price attributable to the house or the improvements, which no longer exist.
Cost bases can also include expenses like interest and rates in some circumstances.
No main residence exemption due to lack of dwelling.
50% per cent of the capital gain will be exempt from CGT on the basis that the land has been owned for longer than 12 months (50% CGT General Discount).
No GST would be applicable, as you are not partaking in a profit-making enterprise.
7. Sale of demolished site as Ordinary Income
Any gain will be considered fully taxable by the ATO as being related to a profit-making exercise.
If the ATO draws this conclusion:
The profits would be taxed in full.
There would be no 50% CGT General Discount for 12-month ownership, and
Further, if you construct a new dwelling on one of the subdivided blocks and then sell it immediately after it is finished (before anyone has lived in it for 5 years), then you will be selling ‘new housing stock’ subject to Goods & Services Tax (1/11th) chargeable out of the sale price – paid by the purchaser directly to the ATO from the settlement figure. A lower GST may be payable if the Margin Scheme is used.
8. How do you determine whether a sale is Capital or Ordinary Income?
If the Tax Office believes you have created and sold the surplus land with a view to making a profit and that the transaction has the character of a business operation or a commercial transaction, CGT rules won't apply but you'll be hit with an income tax bill on the entire profit (less costs).
Even a single transaction can be regarded as a business operation.
Tax Ruling 92/3 says: A profit from an isolated transaction is therefore generally assessable income when both of the following elements are present:
The intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain, and
The transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.
The act of building new premises on the subdivided vacant lots demonstrates a profit-making intent.
You might also have GST obligations. That's particularly the case if you decide to build a new house on the surplus land before selling it.
9. Build on New Lot to Live In.
A different outcome exists if you build on the new lot with the intention of living in it, and then you sell off the old main residence.
You may still be able to use the main residence exemption to negate any CGT on the old main residence.
There would be no GST included in the sale price of the old main residence as it is not seen as new premises.
10. Data matching
Many taxpayers have subdivided their land and sold one of the lots off and not bothered telling their accountant or the ATO. In the past this might have been missed by the ATO, but the ATO’s data matching has become more sophisticated, and the incidence of property transactions being identified and subsequently audited by the ATO has increased.
Talk to us
If you are considering subdividing a block of land, speak to us so we can discuss any potential tax consequences. At May Klye & Associates, we specialise in dealing with the accounting and tax aspects affecting property investors, be they residential or commercial. We have well over a hundred property investor clients, and we have extensive experience in getting them the best tax outcome. If you would like to know more, call Noel or Amanda on 03 9585 7555 or email us at firstname.lastname@example.org