By Domenic Festa (Accredited Tax Specialist and Chartered Tax Adviser)

At some stage property owners may consider a development of property, whether that be a particular project (acquisition of a splitter block or proposed unit development), sale of recently acquired property, or realisation of property held long term (whether that be investment property, principal place of residence or a farming/lifestyle acreage property).

The differing tax consequences depend on whether the development of property constitutes a business, profit-making undertaking or a mere realisation of an investment. The differences are significant. A business or profit-making undertaking is taxed as ordinary income, whilst a mere realisation is taxed as a capital gain which might attract a 50% discount if held for more than 12 months or be fully exempt if a pre-CGT asset eligible for the small business CGT concessions.

Whenever such developments are considered, the tax issues are often front of mind.

There are many misconceptions with regard to the tax issues which include property held for at least 12 months is taxed as a capital gain, a disposal of property held in a trust even if acquired for development and sale is capital, a disposal of land after demolition or removal of the residence which had been used as a principal place of residence is exempt from tax.

ATO Developments

These misconceptions have become the subject of an ATO Property and Construction website guidance and Taxpayer Alert (refer to TA 2014/1) with respect to property development structures.

Some relevant points made in these ATO publications are:

  1. A potential buyer of the property making an offer to the landowner before the landowner entered into a development arrangement may be an indicator of mere realisation (para 16).
  2. Where the original intention is to hold the land for a period, and then develop and sell it at a later point in time, it will be considered a profit-making transaction and not a mere realisation (i.e. it is not necessary that the intention or purpose of profit making was the sole or dominant intention) (para 18).
  3. If a property was originally acquired as a private residence or for recreational purposes it would ordinarily be held on capital account (para 25), but if there is also a longer term purpose of profitable resale/development which is a substantial purpose, then the sale may be more than a ‘mere realisation’ (para 27).
  4. Where the property has recently been rezoned, and the landowner actively sought rezoning may indicate that the landowner was engaged in a profit making undertaking or business (para 36). Merely making an application will not be conclusive, but the more deliberately, determinedly and business-like the pursuit of the planning approval or rezoning, the more likely the activities indicate a profit-making purpose. For example, challenges to planning decisions (para 44).
  5. However, where a potential buyer of the property made an offer, the landowner rejected the opportunity to dispose of the land outright, and entered into a development arrangement to pursue a greater profit, it may indicate that the landowner has ventured the land into a development business or profit making undertaking (para 38). This will be the case where the nature of the arrangement exposes the landowner to the risks and rewards of developing the land (para 39).
  6. The level of active involvement of the landowner in any development activities – The more actively involved in the various aspects of the development, the more likely the landowner will be carrying on business (para 68). Where the landowner is undertaking or project-managing a development him/herself, or is using a related entity, the level of active involvement is likely to be high (para 69).
  7. The fact that a development arrangement has been entered into is not conclusive in itself. What will be particularly important is the nature of the arrangement. Under an agency relationship, the landowner is most likely to be in the business of property development or undertaking a profit making venture (para 84). On the other hand, a suitably formulated joint venture is more consistent with a mere realisation.
  8. A large-scale development is more likely to be considered a profit-making transaction.

Case Example

A decision that fits squarely within the comments referred to above is that in McCarthy and Commissioner of Taxation [2021] AATA 1511.

In that case, a taxpayer and her husband purchased a residential property on 27 August 2016. Settlement occurred on 31 October 2016. At the time of settlement, there was a long-term tenant in residence. Within two weeks of settlement the couple lodged an application to split the block into two lots. The tenant vacated in May 2017 and development commenced in July 2017.

The couple attempted to argue that they intended to hold the property as a long-term rental investment.

Despite the development being conducted in a decidedly non-commercial manner and very non-businesslike, the Tribunal concluded that the stated intention to hold the property as a long-term investment was not supported by the evidence, the test is not whether the transaction was carried out in a businesslike manner but whether the transaction had a profit-making purpose or was a mere realisation. The purpose in this case was clearly an acquisition for subdivision and sale and therefore profit-making.

Our Experience

The Principal of Steps Law has extensive experience in advising on matters involving property development. Some typical examples of our involvement are:

  1. Development site sold for in excess of $10 million. Site was acquired by a person employed in the property development industry, and for that reason alone, ATO auditors determined that this was a profit-making. We focused on the prior land transactions to convince the ATO, after objection, the realisation was a mere realisation.
  2. Property development of several thousand lots. We focused attention on the proper characterisation of the agreement and convinced the ATO that the proper characterisation was as a joint venture and a mere realisation, and not as a sale or agency.
  3. Subdivision and sale of pre-CGT property. We focused attention on the nature of the works to be undertaken to achieve the subdivision and convinced the ATO it was a mere realisation and exempt from tax.