Partnership building 2 residential apartments above a commercial property

Question

Dear Julia,

A bit of background information to start off with:

· A friend and I bought a single-story shop over a year ago fifty-fifty with the intention of building two residential apartments above it, one each. On completion of the build we aim to sell off the shop, or if that isn’t possible, rent it out.

· We had to buy the shop as a ‘going concern’ as the current tenant was going to continue leasing for another 10 months. We were happy to lease out the shop for this time to offset the mortgage with rental income to some degree during the planning phase of the build.

· We were advised to become a partnership to be able to look after the income and expenses of the shop during this period and also use it as a means of pooling our finances. Critically we also had to register for GST to enable the GST ‘free’ sale to go ahead associated with a ‘going concern’.

· 12 months later and the lease has finished, the tenant has moved out (the shop is empty) and planning permission has been granted.

· Note neither my friend nor I have bought or own a property before and are currently renting.

Our problems have started to arise once we delve deeper into the tax situation as we’ve recently been told that because we are currently an ‘enterprise’ (so we could run the shop while we had a tenant) we are effectively classified as developers regarding the building of the apartments above the shop and therefore will be hit with both GST and CGT (100%) in the future if we were to sell one or both apartments before 5 years. Is this correct, everything I have read on the topic seems to relate to either residential properties or commercial, but not both together as in our situation?

We purchased the shop with the intention of building ourselves an apartment each (with strata titles etc) and were of the belief that these would then be classed as our main residences. This was assuming that then after 12 months minimum the CGT would be halved and there would be no GST on any future sale.

What options are open to us to ensure that the apartments are treated as our main residences and not as a product of a business venture? For instance is there any way of separating ourselves from the business side of the shop with regards to the apartments perhaps? Would/should we de-register for GST now we’re not obtaining rent? Would that then be an issue with selling the shop in the future after the build, or perhaps renting it out again instead (based on the assumption we haven’t sold the apartments)? Obviously we wouldn’t be able to claim any GST credits during construction but that would be better than paying it on a sale.

Does the timing of sub-division make a difference in these situations? I.e. if we split the property titles before or after construction will it have an influence?

Thanks for your time and looking forward to your reply.

Kind regards,

Jon

Answer

$1,001 to $5,000 net of GST -12 months after the first 30th June after the purchase and again 12 months later. For example purchase in July 2000 the first adjustment date is 30th June, 2002 the next adjustment date is 30th June 2003 and no more after that.
$5,001 to $500,000 net of GST -12 months after the first 30th June after the purchase and again 12 months later and each year after that for the next 3 years i.e. 5 adjustment periods. For example purchase in October, 2001 the first adjustment date is 30th June, 2003 then 30th June, 2004 then 30th June 2005 then 30th June, 2006 then 30th June, 2007 and no more after that.
$500,001 or more net of GST – 12 months after the first 30th June after the purchase and again 12 months later and each year after that for the next 8 years.
So at the 30th June 2012 you will have to make an adjustment in your BAS, if you continue to be registered, anyway.
Division 138 requires you if de registering to pay back the GST claimed on items for which the adjustment period has not expired. Basically the same result so why not just de register and be rid of it.
Once you are not registered for GST you are not required to register just because you choose to sell a property you built with the intention of holding as a rental or if you simply sell a commercial property. Section 23-5 states that if the annual turnover of supplies you make in the normal course of your enterprise, exceed $75,000 you must register for GST. Section 185-25 excludes from the calculation of annual turnover the supply of a capital asset. As you didn’t build the units or hold the shop as part of your stock for resale then the sale of them is simply the sale of a capital asset and not included in the annual turnover. Therefore their sale will not force you to re register.
This means that even if you do rent the shop out again, providing the rent is less than $75,000 pa you will not be required to register for GST, so when you eventually sell the shop you will not have to charge GST, though whether this is good or bad depends on whether your buyer is registered, their ability to understand how GST works and the basis of the selling price negotiations.
It is going to cost you a lot to deregister for GST but if you don’t section 129 adjustment rules will force you to pay the GST back anyway so in my opinion you would be better to just de register and get rid of the problem completely.
The information you have received about being a developer is not correct, you are allowed a change of purpose but nevertheless deregistering for GST will remove any doubt
GST treats partnership strangely compared to other tax law. This is explained in GSTR 2004/6
Now as for CGT and your main residence exemption. As long as you own the property in your name and at least live in it initially you can cover it with your main residence exemption. The “partnership” is nothing more than a compliance necessity rather than an actual legal entity.
The whole of the property will qualify for the 50% CGT discount (if not the full main residence exemption) after 12 months of ownership even if the nature of the title has changed.
Don’t worry about the fact that tax law has artificially created a partnership situation for the receipt of the rent and GST. It will not affect how your profit on the sale will be treated.
But there is one catch, technically if you subdivide you and your friend will both own half of each other’s property and it would be a CGT event to transfer half between you so you can own each unit individually. Fortunately you say you are going to strata the units which means you will be entitled to the rollover relief of section 118-42 but this is only the case for strata titles.
You really need professional advice in more detail, which is beyond the scope of just one askbantacs question, but the above information will make sure that advice is on the right track.

There is much to this issue. Please don’t act on this advice without
first going over the details with an accountant.

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