My wife and I both work full time and live in our house which is our principle place of residence, which we’ve owned for 6 years. We never intended to develop it however recent changes to our local councils planning controls mean that we could knock down the house and build 2 new detached houses on the site (dual occupancy strata titled subdivision as the land isn’t large enough to subdivide the block using torrens title). By selling one and living in the other we hope to substantially reduce our mortgage.
My question relates to CGT. What would be the most tax effective way to manage the situation? For example, could we initially live in and nominate house 1 as our PPR, and rent out house 2, then after a few months, sell house 1 and move into house 2, would this defer any capital gain?
Your first concern should be that the main residence exemption attaches to a dwelling. If the dwelling is demolished then in theory the main residence exemption is lost with the dwelling. The ATO did not consider this to be the intention of the legislator so they have made a concession in ID 2003/232 http://law.ato.gov.au/atolaw/view.htm?docid=AID/AID2003232/00001 This only applies if the property has been fully covered with your main residence exemption to date and you move into your new home immediately that it is finished, not covering another property with your main residence exemption in the gap.
Now once you have got all that out of the way the house you move back into could be sold, later, with no CGT liability. I say later because if you build this house with the intention of selling it then the main residence exemption won’t apply and you will have to charge GST.
Charging GST is to be avoided at all costs because you will not get any more for the property but will have to give the ATO part of the sale proceeds.
Now to the one that you don’t move straight into, again if you sell soon after building you will be considered to have built it to sell then you will not be entitled to even the 50% CGT discount because it is a business proposition and you would have to charge GST on the sale. Make sure you use the margin scheme (see booklet below). I assume that because of the title you do not have the option of just building one house for yourself and selling the other off as vacant land. You see it is the action of building the house to sell that makes you business like not the simple subdivision.
Considering you are going to demolish a perfectly decent home to undertake this development and that if you sell either of them in the near future the ATO are going to take quite a bit of tax off you. Make sure you do the numbers carefully and get an Accountant to review them, there may not be a profit in it at all and consider all the things that can go wrong.
To keep the 50% CGT discount and not have to charge GST on the sale you would need a dramatic change in circumstances forcing an early sale or be able to afford to hold it as a rental for 5 years. If you decide to do this don’t register for GST and of course don’t claim back any input credits during construction. If you build to sell then you are required to register for GST and you can claim the input credits back on the construction of the one you intend to sell.
You should read my how not to be a developer booklet http://www.bantacs.com.au/booklets/How_Not_To_Be_A_Developer_Booklet.pdf
As for the idea of moving your main residence exemption from one to the other, with the exception of 6 months you will not be able to cover both fully with your main residence exemption so nothing really gained. Reference TD 2000/14 http://law.ato.gov.au/atolaw/print.htm?DocID=TXD%2FTD200014%2FNAT%2FATO%2F00001&PiT=99991231235958&Life=20000412000001-99991231235959