With 200,000 new homes required to support long-term population growth, it’s no surprise the construction and property development sectors continue to grow. However with many developments taking months to years to complete, there are many pitfalls property developers need to be wary of. Among them – and the biggest – is tax.
As with any industry, understanding tax implications can make or break the profitability of your development venture. Working with a number of property developers, we share the four most common tax traps we see and how to avoid them before it creates tax-time chaos.
Tax trap 1: Failing to apply for GST
Good Services Tax (GST) is applicable to any businesses earning over $75,000 per year. While property and land development may not seem like goods or a service, the profit or income you make from its sale still attracts GST if over the threshold.
While there are GST credits available, it’s important to chat to your accountant or business advisor before you start your property development. This ensures you not only know when (and if) credits are available, but also if you need to register as well as what provisions you need to make for GST come tax time. This allows you to be proactive and ensures you won’t get caught out.
Tax trap 2: Choosing the wrong ownership structure
Whether you’re investing as an individual, company, partnership or trust, the business structure you choose for your property development project can have major tax implications.
While each has their pros and cons, it’s important to choose a structure that best suits your long-term goals and objectives. This is where a discussion with your accountant or an advisor for business is key.
By sharing your goals, the purpose of the purchase, and how you will dispose (or ultimately dispose) the asset, your accountant or business adviser can provide insight into the right business structure for you. This proactive approach not only makes things easier at tax time but can also put you in a better financial position over the long term.
The most common mistake for first-time developers is to do the project under their personal names or as a sole trader. While this is convenient, any profit made will be attributed to your overall personal income. This could result in you being taxed at the highest personal tax rate.
Tax trap 3: Your investment moves from capital to revenue
What you will be using the property for and the purpose of its purchase can determine whether the land or property will be classified as capital or revenue.
If the goal of the land or property is to generate income over time (and not to sell for profit), it is usually defined as a capital gain. However, even if this was the original purpose, any changes could result in it being defined as revenue.
As a general rule if your property will be considered as a revenue account if it is:
- Acquired for sale or exchange as part of your ordinary day to day business (known as a trading stock),
- Has been purchased as or moved into a profit-making scheme or plan
Moving from a capital to revenue account also means it is subject to income tax, with the same rules applying to any land subdivided from your primary residence also.
How the land or property is classified could also have Capital Gains Tax implications. This is why it’s essential to chat to your taxation accountant or business advisor before you sell the property or develop the land to ensure you’re making an informed decision.
Tax trap 4: Making assumptions about Capital Gains Tax
Capital Capital Gains Tax (CGT) can be complicated for taxpayers on all levels, but it can be even more complex for property developers without proper due diligence.
Simply put, CGT applies to any profits you gain from selling assets. This applies to land or property as well as developments. Capital gains (and losses) are reported with your tax return, with any gains applicable for CGT.
While your primary residence is exempt from CGT, any properties or land being traded for profit (trading stock) or a property considered to be part of a profit making scheme is not. The 50% CGT discount also applicable for primary residence is not applicable to any properties or land where the:
- Development project is set up as a company
- Property or land is held for less than 12 months
- Development activities classified as a business venture by the ATO
If the above applies, the property or land is seen as a trading stock and will be treated as trading income and be taxed at a higher rate.
The year you purchased the property or land matters
Capital Gains Tax (CGT) rules also differ depending on when you purchased your property or piece of land. For land or property acquired before 20 September 1985, CGT does not apply. However, any property improvements or additions made after this date may be subject to CGT. This is why it’s essential to chat to your business adviser before making any decisions to sell your investment.
How to avoid these tax traps
With so many factors involved, understanding tax implications for your property development can be complicated.
The key to avoiding these tax traps and common pitfalls is taking a proactive approach. By meeting with your accountant or business advisor on a regular basis, you can make informed decisions, better understand your financial position, and make provisions come tax time.
Even if you don’t meet with your accountant or business adviser regularly, we recommend quarterly check-ins or seek advice before any new sales or purchases. This not only allows you to better assess risks but also put preventive measures in place.