Tax Q&A: Subdivision and CGT

Question: I purchased a property in 2010. I lived in it for 12 months and then rented it out for six years. Twice during that period, I moved back into the house for approximately four weeks and did some renovations – I repainted, put a shed up and freshened up the property. I have now knocked down the original house and subdivided it into three separate lots. With no house on it, the block was valued at $260,000 under one title. The three lots are now valued at $165,000 each. I have not claimed any main residence tax breaks for any other properties in the meantime.

Can I sell one lot for $165,000 and apply the 50% CGT as I lived there for 12 months? And would my profit be based on the amount of $260,000/3 = $87,000?

If I sell one of the lots for a profit of $78,000 ($165,000 minus $87,000), can I then apply the 50% rule? That is, $78,000/2 = $39,000?

Thanks, Matt

Answer: The first consideration is the limits of the main residence exemption from CGT. You have bought a house, lived in it, then rented it out for a period of time. From what you have said, you did not exceed the time living away from it to adversely impact on your main residence exemption, and you also have not claimed any other property as your main residence during the period of ownership.

If you had then just sold it, the capital gain would be exempt. You have, however, demolished the house and subdivided the vacant land. The CGT exemption does not apply unless it involves a dwelling. Section 118-115 of the Income Tax Assessment Act 1997 specifies that a dwelling is a building wholly or mainly for residential accommodation. While it can include houses, caravans, houseboats and mobile homes, it specifically can only apply to land if the land is under the dwelling. That is, if there is no dwelling, there can be no main residence exemption.

The land, when it is sold, will therefore be taxed, without any main residence exemption from CGT that may have applied had the dwelling still been there.

The next significant taxation issue is whether the CGT provisions or the ordinary income tax provisions will apply to the profit on the sale of the blocks of land.

If the CGT provisions apply, then the capital gain will be the difference between the net sale proceeds and the cost bases of the blocks. The 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. Fifty 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.

Of concern, however, is the risk that the gain will be considered entirely taxable by the ATO as being related to a profit-making exercise. If the ATO concludes that when the house was demolished a profit-making undertaking commenced, then the market value at the time is likely to be the deemed cost base and the profits would be taxed in full. No discount for 12-month ownership would be applicable.

If both the CGT and the other provisions of the 1997 Tax Act could apply, Section 118-20 of the 1997 Tax Act specifies that the other provisions would apply.

The final bad news is that profit-making schemes with vacant land and GST often go together, and you should get some professional assistance on whether you may also have GST exposure on the sales.

Need to know

-CGT exemption can only apply when a property includes a dwelling.

-If a dwelling is removed, the land when sold is generally taxed, without any main residence exemption from CGT.

-Profit from vacant land is often linked to GST.

Daniel Rands

Partner at PKF Chartered Accountants

and Business Advisers Tasmania