CGT & Subdivision

Question

I purchased a 1.5 ha block of land with a shed on it in July 2011, I moved into the shed on the day of settlement (due to not being able to afford to rent elsewhere) and got building approval (owner builder) for a small house in September 2012. I had hoped to take advantage of the first home owner grant and get started on the house, but found out that I wasn’t able to qualify for the funds until after the house was complete; this threw a spanner into the works and being an owner builder, I did not think it likely I would be able to borrow enough for the full house construction. Prior to purchasing, I had been aware that there may have been some subdivision potential for the land, so at this time I researched this in more detail as I thought it could be a way to finance my house construction. I applied for subdivision approval in November 2012 and gained approval for a four lot subdivision in January 2013. I have now completed the subdivision and have 2 blocks for sale. I was expecting to pay CGT on the sale of the two vacant blocks, and cover the sale of the shed block with the PPOR exemption – I am not concerned with the fourth block as I do not intend to sell it (that’s where my house will be). I have had the two vacant blocks for sale for a while and have been thinking that at least one of them would be easier to sell if it had a house on it; my question is, if I get a builder to build a house on one of the vacant blocks and I move in for at least three months (after selling the shed block – my current PPOR), will I be able to sell the house CGT free?

Answer

Your first problem is the onus of proof that you did not buy the property with the intention of subdividing to sell at a profit, rests with you. If your intention was to subdivide for profit then you are in business which means no main residence exemption or 50% CGT discount and you would have to pay GST on the sale proceeds.
You have to be able to argue that you are merely realising an asset. There is heaps of information about this issued in our How Not To Be A Developer booklet http://www.bantacs.com.au/booklets/How_Not_To_Be_A_Developer_Booklet.pdf
Evidence that the bank wouldn’t lend you enough to build is the cornerstone of your argument. I am assuming you didn’t do any more to the blocks than the bare minimum required by council. How did you get the money to subdivide? Another apparent flaw in your argument is that you may be selling more blocks than you need to actually pay for your house.
Anyway if you are really up against the wall because need to sell something to be able to build your home, whether you are up for tax or not you will still go ahead. I assume rather than continue to live in the shed until you come into some money. What you need to concentrate on is collecting evidence and not contradicting it, showing that you just wanted to get enough money to build your home. If you go beyond this to sell more blocks than necessary or spec building a house you will destroy a plausible argument. Going further than merely realising some land so you can build your house could not only expose that block to GST and no 50% CGT discount but also the one or two blocks you may have been able to sell without being considered in business. The ATO can use the benefit of hindsight in their argument.

Why I don’t want you to build the house:
In paragraph 273 of MT 2006/1 http://law.ato.gov.au/atolaw/view.htm?Docid=MXR/MT20061/NAT/ATO/00001 there is an example of a person who builds a duplex and sells one side so they can afford the other side. He is caught as a business ie subject to GST and no 50% CGT discount but fundamental to this situation is that he built on the other block and that it was his plan right from the time of purchase.
I assume you are considering trying to argue that you built the house as you home but didn’t like it for some reason or another so built a different one on another block. Again burden of proof on you. Not a strong argument, all sorts of things they can poke at such as – well why did you keep the final block if you weren’t originally intending to build your final house there.
Recently in August’s case the ATO decided that a person who bought up, slowly, over 9 years a strip of shops was doing so to resell at a profit! The ATO won in court with arguments like, well you have a relative who does up shops to resell and he advised you that they would be a good buy and if you didn’t intend selling them why did you ask the real estate agent how much he thought they were worth. Just gives you an idea of how they can use what seems innocent against you.
Generally the construction of a house on land can take the land from being a mere realisation of an asset to a business venture because the house was not necessary to be able to sell the asset. You can only avoid this by saying you built it as your home, burden of proof again. What is your excuse for only living there for three months.
You cannot cover two places with your main residence exemption (with the exception of the 6 months overlap rule which has very limited application) at the same time. So if you intend covering the shed block fully with your main residence exemption you will only be allowed to cover the house with your main residence exemption for the 6 months before you sell the shed block through to the time you sell the house providing you move into the house immediately after it is completed, continue to own it for another 3 months before signing a contract to sell and that the gap between the six months before selling the shed block and moving into the house is not more than 4 years. The gain made on the house and land if you get away with saying it is your main residence will still be subject to CGT by being apportioned between number of days covered and number of days not. So the tax saving may not be much at all and consider the extra risk of building. A few months back I did the numbers on a true life situation in Australian Property Investor Magazine. On the surface it looked like building the house was going to increase the profit on cutting off the back yard by $30,000 but by the time the 50% CGT discount was lost and the sale exposed to GST it actually showed a lesser profit than selling the land vacant. Not to mention the problems associated with building.
Normally I would suggest you get a ruling before you go ahead with the idea of building the house but in this case what are you going to say in the ruling? I am considering building a house but just in case I decide soon after it is completed that I don’t want to live there I need to know that you would not consider me to have built it to sell!

Get A Ruling Re the Subdivision
Hopefully now having talked you out of building the house, it is certainly worth getting a ruling on whether the subdivision and selling of the vacant blocks is going to be considered a business. I think they will rule in your favour but it is important that you be absolutely sure whether GST applies or not. If it does there will be some benefit from using the margin scheme when you sell. It would be near impossible to try and use the margin scheme after you have sold but the ATO audits you and decides that GST does apply

A Shed can be a main residence:
Providing it is not caught up in a business, as discussed above, you will have no problem protecting the block with the shed on it 100% with your main residence exemption reference Summer’s case 2008

Direct Answer to your Question:
No, You will not be able to sell the newly built house completely free of CGT if you have already covered the shed block with your main residence exemption. With the exception of 6 months you can not cover two properties with your main residence exemption so a portion of the gain will be taxable. Worse still you might be considered to have built it with a profit making intention so no 50% CGT Discount, no main residence exemption and have to charge GST plus exposing the other blocks to this by association.

What you need to do next:
You really need to go over this in detail with an accountant discussing all your options and preferences and the tax consequences on your potential profit. Also to help you apply for the ruling before you sell any land. Now if in amongst that discussion you decide not to cover the shed block with your main residence but say instead you want to be able to cover the block you build you real home on and cover it right from day 1 so you don’t have the record keeping nightmare of a partial main residence exemption, there is a little known ruling TD 2000/14
http://law.ato.gov.au/atolaw/view.htm?locid=’TXD/TD200014/NAT/ATO’
that will still allow you to use section 118-150 the 4 year rule to cover your final house block instead, assuming you move into your final house within 4 years of the original purchase.
Alternatively, if you do end up living in a property that will have some CGT exposure make full use of section 110-25(4) IT 1997 to increase your cost base by absolutely everything associated with you living there that has not been claimed as a tax deduction ie cleaning materials, lawn mower fuel, interest, insurance, rates etc etc

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