What happens when your property development changes?

The basic tax position for a property development is:

  • A capital asset is something that you acquire with the intention of holding it and generating a return from
  • Activities you undertake in respect to the property may amount to the carrying on of a business, or an isolated profit-making
  • If you dispose of a capital asset, then CGT provisions
  • Merely claiming a capital intention may not be sufficient to meeting the approval of the ATO or the courts.
  • If you enhance the value of a capital asset in order to increase the return when it is sold (for example: you obtain development approval for a farm) you may still be ‘merely realising’ the capital asset, or maybe not, depending on the degree of enhancement and all the factors considered in farm
  • If your activities with a capital asset become more than mere realisation (or an initial capital intention cannot be established), you cannot access CGT concessions and you will then need to consider the income tax
  • Your intention in relation to a capital asset can

The final point here is key – your intention in relation to a capital asset can change.

A capital asset may turn into a profit-making transaction or business. The land may not have been originally purchased with a profit-making intention, however, due to changing circumstances, it may then venture into a business or profit-making transaction.

Let’s explore this issue with an example.

Mr. Beach purchased ten acres of land in 2002 in a fairly remote seaside location so he and his family could enjoy the benefits of holidaying at the beach. In 2010, following discussions with friends and colleagues, some of which had experience in property development, he decided to subdivide and develop the land. The predominate reason was the significant increase in land value at this now rather popular seaside location. As a secondary issue, the family were no longer using the land for their recreation as they once were. Mr Beach embarked on a significant development with 50 residential lots. The subdivided land was then sold at a significant profit.

In this scenario, the profit on the development would be considered on revenue account. Once Mr Beach decided to develop due to the significant increase in land value and the interest in property in the area, the land transformed from one which was held for ‘domestic purposes’ for the owner to one that was purely driven to engage in a commercial venture to make a profit. The transformation turned the development from a ‘mere realisation’ to an assessable transaction. Mr Beach had ‘ventured into’ a profit-making scheme and the land was no longer held on capital account.

While this particular scenario may be rare, the fact remains that the ATO and the courts will closely examine the facts of any scenario and will look to clarify whether the intention and/or purpose has changed from one that would be considered capital to a business or profit-making scheme and therefore on revenue account.

There have been many legal cases in this area, particularly ones involving farmers looking to undertake subdivision activities themselves, rather than simply offloading the farm to a property developer.

The theme that developed from these farming cases was that if the farmer didn’t look too much like they were actively doing things a developer would do, the transactions would be considered a mere realisation of a capital asset to maximise the return to the farmer on the disposal of the family farm. If there is a rule of thumb, it is that the greater the direct involvement of the farmer in the subdivision activities, the more likely they would have stepped over the line into the business of property development, where the profits are then subject to tax on revenue account.

Similarly, in the example above with Mr Beach, if he simply decided to seek a subdivision and sell without any development, it may well have been considered a mere realisation of a capital asset.

The law in this area is not just about mere realisations becoming development activities, or how long an asset has been held; it also looks at profit-making intention and isolated profit-making transactions amounting to something less than a business.

Without wanting to generalise, the test with isolated profit-making transactions or one-off ventures is whether you intend to make a profit from entering into the transaction.

There have been many cases that have looked closely at this issue of intention and purpose. What they tell us is that you must prove you didn’t have a profit-making intention in order for the transactions to be taxed as a capital gain.

In a perfect world, you, as the property developer, will get tax advice when you are considering any developments and ensure that there is documentary evidence of your intention at the appropriate time. (Hopefully you’re reading this before your first development!)

In the real world, though, there are often conflicts between your stated intentions and the activities you actually undertake, including documents and plans provided to financiers and others.

While the ATO talks about wrongful and inappropriate claims and exploitation of the system, litigation about the distinction between capital and revenue has been happening ever since there were different tax outcomes depending on how profits were categorised, and there is no one size fits all tax treatment for property development.

There will always be commercial activities that start out as capital, and which require a change of plans for a host of reasons, including liquidity and changed market conditions. Such a change is not, on its own, a problem from a tax point of view.

At the end of the day it all boils down to the facts and circumstances of each particular case, and how much appetite you have for engaging in potentially lengthy and costly disputes with the ATO.

The ATO is willing to take on clever arguments about developments on capital account. However, it may not be the clever argument that lets you down, it’s all about the stuff that lawyers always get excited about, evidence. Consequently, you must document your intentions at the time of acquisition and monitor changes of use while you hold the development.

If you are planning a development or even commenced one, don’t hesitate to get in touch if you’d like some advice.

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Tony Dimitriadis
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