We are considering knocking down our main residence, subdividing the land and building 2 x new homes on this land.
We will live in one of the homes.
We are undecided whether we rent or sell the second home.
Can you please help us understand any CGT implications of selling versus renting this second house and any strategies we can use to minimize any potential capital gains.
ID 2003/232 is your first important area of concern http://law.ato.gov.au/atolaw/view.htm?docid=AID/AID2003232/00001
Your main residence exemption attaches to your dwelling. According to legislation when the dwelling is destroyed your main residence exemption is lost forever. In ID 2003/232 the ATO offer a limited solution to what they see as an unintended consequence in the wording of the legislation. Providing the old house has been continuously covered by your main residence exemption, you move into the new house as soon as possible after it is completed, from demolition to completion is less than 4 years and you cover the new house with your main residence exemption for at least 3 months then you can build a bridge between the two houses and cover that property with the your main residence exemption from the time you purchased the original property. You can’t of course cover any other property with your main residence exemption during that time.
There will be no main residence exemption at all for the other block of land even if part of it was once underneath the old house. You will have to go back to the original purchase price and apportion it between the size of the two blocks to get the first element of your cost base. A different method of apportionment may be necessary if one block is better than the other ie has views. You then add to this the other block’s share of buying costs, demolition costs, subdivision costs etc. Further section 110-25(4) allows, if you purchase the property after 20 August 1991, to increase the cost base by its share of any holding costs such as rates and interest on the land right back to the time you first purchased the property.
If it is your intention to rent the property out then the interest during construction will be tax deductible to you (Steele’s case). If you intend to sell the property then the interest during construction will be a reduction to the taxable profit on the sale. You see if you build with the intention of selling then you are in business so the profit you make will be taxed as normal income ie no 50% CGT discount. You will be subject to CGT (with the 50% discount) up to the day you committed the land to the project. The line is set with the market value. Any profit from that point onwards is taxed as your business income. Further you will have to charge GST when you sell though you will be entitled to input credits on the construction costs and use the margin scheme, if the buyer agrees, so that you only pay GST on the margin between the price you paid for the land and the selling price.
If you keep the property to rent and are not registered for GST then you are not required to be registered for GST which means you will not have to charge GST if you do sell it one day. You will not be able to claim any GST input credits on the construction.
If you simply subdivide and sell off the land then you are merely realising an asset so not in business. You will get the 50% CGT discount and not have to charge GST providing you are not registered for GST.
Here is a link to our How not to be a developer booklet.
There are articles in there that go into the points above in more detail.