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 by GSCPA Admin
Q: What is a Non – Commercial Loss?
A: A non-commercial loss is any loss you incur, either as a sole trader or in partnership, in a business that is secondary to your main source of income.
Can I offset my loss against my main source of income?
To assess whether you can offset your business loss from your other income, or you have a non-commercial loss that you defer, you first have to look at your other income to ensure it is below $250,000.
Your other income is the income you receive, other than from your loss making business and includes:
- Taxable income
- Reportable fringe benefits
- Reportable superannuation contributions
- Total net investment loss
If this is less than $250,000 you can offset your losses in the current year if you pass any of the four tests below:
Assessable Income Test
To pass the assessable income test, assessable income from your business activity during the income year must be at least $20,000. If you were in business for less than a year, or you stopped carrying on your business activity during the year, you can make a reasonable estimate of what your assessable income would have been for that full year.
Profits Test
Your business will pass the profits tests if it has made a tax profit in three out of the past five years (including the current year). If a business makes a tax profit for three years running then it will pass the profits test for the next two years regardless of whether it makes a loss, since three out of five consecutive years will be profit years.
Real Property Test
You will pass the real property test if real property of at least $500,000 in value is used in your business on a continuing basis. Real property includes land, structures fixed to the land and interests in that property, such as a lease of that property.
To assess whether your real property assets are at least $500,000 in value, you may value them at either their reduced cost base or market value.
If you use the real property in more than one business activity then you must divide the value between the different activities. This is the same concept if you use private portion on the real property
Other Assets Test
You must have used other assets whose value is at least $100,000 in carrying on the business.
Examples of other assets include;
- Depreciable assets measured at WDV
- Trading stock measured at cost, market or replacement
- Leased assets measured using future lease payments
- Trademarks, patents or copyrights measure at reduced cost base of the asset
Assets which are excluded from the Other Assets Test include;
- Real Property Assets taken into account for the real property test earlier
- Cars, Motorcycles and similar vehicles
- Assets under construction
What if I fail the four tests?
If you don’t pass any of the four test mentioned above, you can’t deduct your business activity loss in the current year. Instead, you must defer your loss for use in a later year.
There is no time limit on how long you can defer your losses. Your loss can be deferred indefinitely until one of the following applies:
- There is a profit from your business activity, in which case the deferred loss can be offset to the extent of the profit from the business activity
- You meet the requirements mentioned earlier
- The Commissioner exercises his discretion to offset the loss.
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