With the cost of property prices in Australia constantly increasing, your home and the land it’s built on are likely to be one of your most valuable assets.
This may lead to you considering how best to maximise the value of the land you own by subdivision, whether by retaining your home and subdividing surplus land or opting for a full knockdown and rebuild.
Before making a decision, it is important to fully understand the tax consequences of the options available.
Subdivision
Subdivision of land involves breaking up the parcel of land into smaller, separately registered blocks. Rules vary between councils; however, generally, blocks of around 450 m² and 600 m² are suitable for subdivision.
There are numerous costs associated with the subdivision process that you need to be aware of and also need to include in any feasibility and budget projections.
Main residence exemption
If the land that you are considering as a subdivision option has the family home built on it, their portion of land may be eligible for the ‘main residence exemption.’ Subject to basic eligibility criteria, such as being the family home and not being used to produce income, this exemption applies to the dwelling you reside in and up to a maximum of 2 hectares of surrounding land.
The main residence exemption is one of the more generous tax concessions, making any potential gains or profits from the sale non-assessable for tax purposes. There are additional provisions that may change how the main residence rules affect you. A prime example is the ‘6-year rule,’ which allows you to treat a property as your main residence for up to 6 years, even if you rent it out during that period, so long as you do not nominate another house as your principal place of residence.
Goods and Services Tax, Capital Gains Tax, and Income Tax
Although Goods and Services Tax (GST), Capital Gains Tax (CGT), and Income Tax are three separate taxes, the application of these taxes is dependent on the same defining features of your subdivision. These features could include cost, frequency, scale, and sophistication, among other factors.
For small-scale land subdivisions, generally only capital gains tax applies, and the transaction would not attract Goods and Services Tax. When your subdivision involves more sophisticated planning and costs, sales may be subject to both Goods and Services Tax and Income Tax.
Capital Gains Tax (CGT)
Capital Gains Tax applies when you sell an asset, such as a portion of your land, for more than you paid for it. Note that the actual subdivision itself is not a capital gain event. A tax liability arises only when the asset is sold. As stated earlier, CGT generally applies to less sophisticated transactions, such as the one-off sale of an unimproved block.
The ‘capital gain discount,’ also known as the 50% discount, may apply if the original parcel of land was acquired at least 12 months before the sale date. This effectively reduces the tax bill to half of what it would be if the sale were treated as ordinary income.
The lot with the family home would still be eligible for the main residence exemption, as long as it would have been eligible had it not been for the subdivision. The original cost of the property, as well as any improvements, would need to be apportioned between the subdivided lots on a reasonable basis.
Income Tax
Income tax applies to commercial ventures with profit-making intentions. Without the capital gains concessions, the overall tax payable would be greater for every dollar of profit than its less complex counterpart.
If you plan to build on the subdivided lot, you also need to consider questions such as whether you are required to register for Goods and Services Tax (GST) or whether you can utilize the ‘GST margin scheme’ to reduce the overall GST payable on the sale.
Before you subdivide
Subdividing and building can be an expensive process. It’s best to plan ahead and understand your cash flow constraints and tax implications before committing.
This article was co-authored by Lawrence Taing, Assistant Manager Business Advisory at HLB Mann Judd Melbourne