21/11/2011
Question: I’ve had my home for more than 20 years,but have decided to downsize and move closer to the city. It’s a pretty old place and I was just wondering what the merits are of simply knocking it down, subdividing and then selling the land. It’s my PPOR, so will I have to pay CGT?
Answer: To explore this issue, I’ve chosen to examine the capital gain for a couple who bought a house in 1987 for $55,000 (house valued at $20,000 and land $35,000), and sold in 2010. This is then compared to the gain to be had from demolishing the same house in 2008, subdividing the land into two blocks and selling the blocks of land in 2010.
I’m assuming subdivision costs of $20,000; that the couple’s marginal tax rates are 38%; that costs associated with the sale of the main residence are equal to the cost of selling the two blocks; and that the circumstances of subdividing the land were not considered to be an “enterprise” for GST purposes and therefore GST does not apply.
Scenario 1
The couple purchased the home in 1987, lived in it for 23 years and sold the house in 2010 for $355,000. At face value, the couple has received a “capital gain” of $300,000. Under the Income Tax Assessment Act, the couple may take advantage of the main residence exemption, thus their capital gain is effectively tax-free.The cash flow in this case is $355,000.
Scenario 2
The same house was purchased in 1987, but demolished in 2008 in order to subdivide the block and sell the two smaller blocks. The sale of both blocks of land in 2010 totalled $420,000 ($220,000 each). This would seemingly represent a gain of $365,000, which is $10,000 better off than selling the house.
However, with reference to ATO ID 2003/248 (available from the ATO website) and Section 118-165 of the ITAA 1997, the taxpayer is denied a main residence exemption on the capital gain made on the disposal of the land.
Put simply, the main residence exemption no longer applies and the couple is liable for tax on the capital gain made on the land for the entire 23 years of ownership.
The gain on the blocks is then worked out as follows:
Capital Gain = Net Proceeds from Sale – (Original Purchase Price – Value of building at Purchase + Subdivision Costs)
Capital Gain = $420,000 – ($55,000 – $20,000 + $20,000) => $365,000
This gain is halved for tax purposes as a result of the 50% Capital Gains Discount (allowable for assets held for over a year).
Therefore: Taxable Capital Gain = $182,500
We then multiply this figure by the tax rate 38% (add 1.5% Medicare levy) to determine CGT payable.
CGT Payable = $182,500 x 39.5% => $72,087
The cash flow in this case is = $420,000 – $72,087 => $347,913
Conclusion
By opting to demolish, subdivide and sell their land, the couple is approximately $7,100 worse off than they would have been if they had simply sold their home (without the effort of demolition and subdivision). So if this answer highlights nothing else, your main residence has special tax treatments which need to be considered before you decide to demolish the dwelling. Professional advice in these circumstances is a must.
Answered provided by Dom Cosentino, Kennedy & Co Chartered Accountants (www.kennedy.com.au)
