Posted on November 22, 2017 by Tom Francis
Buying an older, run down house in a good location and redeveloping the site has become such a popular investment option in Perth that building companies now operate specialised divisions to service this market. While the building process has become easier the tax law surrounding the projects remains complex and unless properly considered can quickly eat through any potential profits.
Between 2008 and 2010 an experienced property developer, who unfortunately was not a GeersSullivan client, completed construction of 12 apartments in Mandurah. The sudden downturn in the market caused by the Global Financial Crisis prevented a quick sale of the apartments and it was 2015 before the final sales were completed. The downturn in the market was so severe that the developer recorded an average loss on each unit of over $100,000. Before commencing the project, the developer had consulted with his accountant who advised that the sale of land and buildings could be treated as a capital gains tax event. The developer had received conflicting advice from friends involved in similar projects but chose to push ahead.
In 2015 the ATO commenced an audit of the developer’s 2010-2014 tax returns and amended the capital losses to ordinary losses upon determining that the developer was in the business of property developing based on his intentions in commencing the project. As part of this determination the ATO registered the developer for GST and treated each property sale as a taxable supply. The developer was required to remit 10% of the sale price of each unit to the ATO, though fortunately was spared any penalty or interest charges. As it had been over 4 years since the expenses were incurred, the developer was outside of the BAS amendment window and was unable to retrospectively claim any GST credits on the cost of building the apartments or to apply the margin scheme.
In total, the developer lost close to $2 million on the project. If he had received proper accounting advice and support this loss would have been reduced by over $660,000.
While this is an extreme case, the above holds some key lessons for all tax payers considering property development as an investment choice:
- The act of buying land for the purpose of building and selling houses or apartments is likely to constitute an enterprise and the tax payer will likely need to register for an ABN and GST.
- The ATO pay close attention to the intent of the tax payer when determining if they are in business; in the example above the tax payer was clearly setting out to make a profit from their property development and not simply realise an asset for the highest possible value.
- While having to remit GST can squeeze the margins of any development, failing to register can have expensive consequences in the event of an audit.
- If you have any doubts about the advice given to you by your accountant, ask them to explain the legal context behind their opinion and provide proof for their reasoning.
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Posted on March 9, 2017 by Tom Francis
For our clients in the building and construction industry times are tough; the State Government is forecasting a 26% decline in project commencements compared to last year and prices in some suburbs have decreased sharply. For many this means projects can’t be sold for the price they need to make a profit or break even on their project and as a result many are looking to rent out houses over the short to medium term.
However, it is important to factor in the GST consequences before doing so. The legislation covering GST and property developments is complex but broadly speaking a change of intent from ‘build and sell’ to ‘build and rent’ means the developer is no longer entitled to claim back all of the GST on the costs. The entitlement to GST credits reduces each year for five years or until the property is sold, whichever is shorter, and each year the developer must remit the difference to the ATO. The majority of the GST remitted is paid back in the first year meaning short term rentals also incur a significant adjustment.
On a large scale development this can involve paying tens of thousands of dollars to the ATO each year, sometimes leaving clients worse off than if they had sold the property at a discounted price.
Let us consider the following example:
- Tim and Monica have just finished a three-unit development in their trust, TM Property Trust. The trust is registered for GST
- The land cost them $450,000 including duties and legal fees and they have elected to apply the margin scheme
- The build cost was $550,000 and they claimed $50,000 in GST credits over the 12 months it took to finish construction, bringing their total outlay to $950,000
- A recent valuation by an agent suggested an average sale price of $330,000 per unit
- After paying GST of $16,364 on each unit and agent selling costs, Tim and Monica would receive approximately $305,000 per unit and make a loss of $35,000
- Instead they choose to rent the properties and receive $360 per week for each unit as this will cover their loan repayments.
Over the years the ATO have released a substantial number of rulings on how to reasonably calculate your adjusted GST entitlement, with different methods applicable to different circumstances. In Tim & Monica’s case the most appropriate method is based on how long the intention was to ‘build and sell’ vs how long the intention is to “build and rent”, resulting in over $32,744 being remitted to the ATO after the first year and $44,583 being remitted over the full five years. After 1 year of renting Tim & Monica would need to achieve a sale price of $341,000 per unit to be better off than they would have been selling immediately and $352,581 to break even on the development.
Once a property has been leased it is too late to avoid making an adjustment to GST, even where it is only rented for a short time, and as you can see from the above example the consequences of doing so are complex and costly. We therefore strongly encourage any of our clients who are considering a decision like the above to contact us beforehand to discuss your situation.
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