Are you considering property development? Do you know there are complex capital gains tax and GST issues around this area that can cause trouble for you from the Australian Tax Office (ATO)? While a tax accountant is the best source of help, there is some information that may be useful to know first.
Sometimes property developers might rent out properties to take advantage of the high-demand rental market, rather than selling them straight after construction is completed. As you might know, property developers can claim GST on all the construction costs, which will be taxed on profit upon sales.
On the other hand, if you are classified as an investor, you will be taxed on capital gains subject to a 50% discount if you hold it for more than one year. However, you won’t be able to claim any GST on construction. Therefore, if you change your purpose, there can be complex issues regarding how much GST you need to pay back and whether you will be taxed on profit or capital gains. This article is here to provide you with some general guidelines.
Section A: Property Developers VS Investors
First of all, how do you differentiate a property developer from an investor? The key indicator is your initial intention – whether to sell for a profit after construction is completed or to receive rental income and hold for a long time. If the former, you are a developer; the latter, you are an investor.
However, this intention should be consistent with what you actually do. Factors like scale of activities, effort put towards selling the properties, loan arrangements, written confirmation of purpose when you apply for council approval etc. will all need to be looked at as a whole picture. Only then can we determine and prove your intention.
If you are a property developer, and you advertise a property for a while without successfully selling it, you might decide to rent out on a short-term basis, say a 6-month lease, to reduce your holding costs. In the meantime, you still actively engage a selling agent to market the property and whenever a satisfactory offer comes in you are ready to let it go. In this case, you are still classified as a developer but holding the property for a dual purpose.
You may need to pay back part of the GST claimed over years until you actually sell the property. The details of how adjustments are calculated are shown in the next section. Again, other factors like loan terms will need to be considered to form a whole picture.
Section B: GST Adjustment
If you as a developer start to receive rent, which is an input tax supply with no GST credits claimable for associated expenses, you will need to pay back part of the GST previously claimed. Other expenses relating to the purchase of the property like agent fees are not subject to such adjustments.
The time you need to do adjustments is the 4th quarter of every year until 5 financial years after the year construction is completed or until the property is sold. The amount of adjustment depends on whether you are holding the property on dual purpose and how much rent you receive.
For example, “Gary” is a property developer. He bought a piece of land and finished construction of a house on it on 01/10/2015, which is in the 2016 financial year. The construction cost him $330,000 with $30,000 GST that he claimed back.
On 01/04/2016, Gary decided to hold the package for dual purpose and received rent for $1500 a month. The market value on 30/06/2017 is $510,000. Up until the first adjustment period (June 2017), the creditable percentage of the dual-purpose period is:
100% – ($1500 x 15mths)/($1500 x 15mths +510,000)=95.77%
Note that for the first 6 months, the property was held purely for sales purposes, meaning that the creditable percentage is 100%. The creditable percentage for the whole ownership period till June 2017 is:
100% x 6mths/21mths + 95.77% x 15mths/21mths = 96.98%
GST to be paid back in the first adjustment period is:
$30,000 x (1 – 96.98%) = $905
He sold the property on 30/09/2017 for $520,000. Upon sale of the property, it will be subject to GST adjustment again. The creditable percentage of the dual-purpose period is:
100% – [($1500 x 18mths)/($1500 x 18mths +520,000)]=95.06%
Note that for the first 6 months, the property was held purely for sales purposes, meaning that the creditable percentage is 100%. The creditable percentage for the whole ownership period till June 2017 is:
100% x 6mths/24mths + 95.06% x 18mths/24mths = 96.30%
Further GST to be paid back upon sales is:
$30,000 x (96.98% – 96.30%) = $206
Total GST paid back for the whole period is:
$905 + $206 = $1,111
As shown in the example above, the total amount of GST paid back over the whole ownership period depends greatly on the amount of rent you received. The higher the rent received compared to the market value of the property, the more GST you need to pay back. Note that the creditable percentage will be reduced to zero for the period that you decide to change to an investor completely.
Section C: Margin Scheme – GST Payable on Sales
Now, if you as a property developer sell the property, you will need to pay GST on the selling proceeds. There are various ways to calculate GST payable on sale. Normally, you will be paying 1/11 of the full selling price.
However, ATO has special rules for the construction industry when it comes to selling new residential premises. This is called the margin scheme, under which your GST liability is one-eleventh of the margin on the sale of the property. The margin on sale is the difference between your selling price including rate adjustments and your original acquisition price.
Construction costs, stamp duties and incidental costs upon acquisition are not taken into account. For example, Gary acquired a piece of land for $220,000 and paid stamp duty as well as other legal fees of $15,000. At the time of acquisition, he was not entitled to claim any GST either because the seller was not registered for GST or because they sold on a margins scheme.
He then built a house and sold the package for $550,000. The margin is $330,000 and the GST payable on sale is $30,000. However, if he doesn’t elect to use the margin scheme (i.e. no agreement was made in the selling contract), he will be paying $50,000 GST as others will do when providing taxable supplies.
Residential premises may still be considered new residential premises if they have been held for a dual purpose (sale as well as rent) after construction is completed. However, they are no longer considered to be new 5 years after a complete change of purpose to PURELY investment (rent). In this case, the sale of the property after that 5-year period is input taxed, which means no GST on sales.
For example, continuing with the previous example, suppose Gary completed construction on 01/10/2010. Because of the market downturn, he held the property for a dual purpose until 30/06/2012. After that, he decided to stop advertising for sale and keep the property for long-term investment. On 01/06/2017, he sold the property and the sale was subject to a margin scheme. Should he wait one more month, the sale would not have been subject to GST.
For more information, please follow the link under the reference section of this article.
Section D: The Best & Worst Scenarios
Because of the special GST adjustment rules and margin scheme, you might be hit by not being able to claim back GST on construction costs while having to pay GST on sale. In comparison, very rarely you will be able to claim GST on construction costs while not needing to pay GST on sale. In that scenario, you only get taxed on 50% of the net capital gain.
The worst scenario arises when you change your purpose to purely investment within five years of construction completion upon which you will be paying back the majority of the GST previously claimed. If you then sell the property within 5 years of changing purpose, you will need to pay GST on the sale.
Therefore if you do plan to hold the property for the long term after starting off as a developer, to avoid this scenario, you’d better keep the property on dual purpose for five years after construction. Then, even if you need to pay GST on the sale, you will still be able to claim back the majority of the GST on construction costs.
On the opposite spectrum, if you hold the property for dual purpose for 5 financial years after the year in which construction is completed, and then hold it for purely investment purposes for an extra 5 years, you will get to claim the majority of the GST on construction while not being liable to pay GST on sale. However, you must genuinely be classified as a developer at the beginning and have the financial resources to hold the property for a longer term.
References:
GST & Sale of Property
GSTD 2006/3 Goods and services tax: are settlement adjustments taken into account to determine the consideration for the supply or acquisition of real property?
New Residential Premises
GSTR 2003/3 Goods and services tax: when is a sale of real property a sale of new residential premises?
GST & Margin Scheme
https://www.ato.gov.au/Business/GST/In-detail/Your-industry/Property/GST-and-the- margin-scheme/
GST Adjustments on Change of Purpose
GSTR 2000/24 Goods and services tax: Division 129 – making adjustments for changes in extent of creditable purpose
GST Adjustments on Change of Purpose – Property Development VS Investment GSTR 2009/4 Goods and services tax: new residential premises and adjustments for changes in extent of creditable purpose
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Phil has been the Managing Director of Griffiths Advisory for 29 years, combining his expertise in taxation, business advisory, superannuation, negative gearing, and wealth creation. He also loves an active lifestyle, indulging in surfing, cycling, snowboarding, and spending quality time with his wife and two children.
