Tax strategies for land developments

Question: We are developing land in Western Australia. Currently we have a DIA from the council. We have shown the council a concept (ie, layout for the subdivision that is acceptable to them. We still need to create the submission for sub-division, but this should go though unchallenged as we've already got a lot of input and agreement from council and the Western Australian Planning Commission (WAPC).  

The land is currently held in a unit trust and units are held by just two partners. 

We are looking at ways to fund the development (and current holding) costs and it was suggested to us that:

  • We sell special units in the trust that entitle the holder to a particular lot once the rezoning is complete. These units would not have any voting rights.
  • We price these units at a discount to the actual lot value. A typical lot of 3,000sqm is worth about $160,000 but we might sell the unit for $120,000-130,000.
    • It has been suggested this might be an interesting proposition for super funds.
  • It will probably take us 18 -24 months to get to the point that we can issue the lots. 

I'm interested in the Pros/Cons of this from both a tax and risk perspective including

  • When the lots are transferred what GST/stamp duty is payable and by whom?
  • What are the risks to us, the developers, and to the buyer in this approach?
  • Is this a common practice?
  • What might we do to make this attractive to investors?

 

Answer: Construction and marketing risk are the two major challenges that come with developing residential property and the uncertainties of both have resulted in conservative lending from the big banks for less experienced developers in recent years.

Minimising construction risk is all about smart planning. Choosing the best quality materials and industry approved construction techniques at fixed price contracts with reputable builders. This may seem obvious and I’m sure you have this covered.

The construction of the development for resale is however a business activity and if the total value is over $75,000 then GST registration is required, meaning any profits will be taxed at normal marginal tax rates and not as a capital gain to the receiver. The sale would therefore have to include 10% GST and whilst there is the benefit of GST credits on any accredited purchases during construction, because the properties are being developed for resale, any interest expense on borrowings along the way need to be capitalised and not expensed. Unfortunately this will increase the cost base and reduce profits on sale.

The sale of the units would also attract tax on the seller as well as stamp duty on the buyer and any discounts would still be adjusted by the ATO and Office of State Revenue to reflect market price when it comes to calculating taxes and charges. It is unlikely that the ATO would agree that non voting units would attract a discount as it is common place when buying property (even if off the plan) that the intended purchaser has little to no input on the development but still pays market price.

So instead of selling units, the redemption and reissue of units should be considered, as in your circumstances this could reduce stamp duty under the correct conditions.

Superannuation

You mention using superannuation in some form.

By way of background, on the 24th of September 2007, the federal government introduced new legislation that allowed self-managed super funds (SMSFs) to borrow under certain conditions. This has evolved over the years (I won’t go into the details of how and when in this article) and significantly in September 2011, new draft guidelines were introduced to address specific industry concerns.

These included clarification that an SMSF can purchase “off the plan” and renovations can be completed, but only if non-borrowed funds are used.

All of which represents a major improvement in legislative interpretation for SMSF property investors.

The way forward

Whilst it seems that you are someway down the track with your own project, given similar circumstances, here is how I would have approached the project from start in order to reduce market risk, increase funding opportunities and lessen the need to pay unnecessary taxes and charges.

Federal taxes and state taxes are triggered on the sale or transfer of the trust units or the completed properties. If the investors were part of the original development (rather than a purchaser) then the three taxes (being income tax, GST and stamp duty) would not necessarily be triggered.

Key to achieving this desirable outcome is for the original buyers of the land to collaborate at the start and share the goal of becoming eventual owners of the end outcome, which in this instance would result in a four-way split and a property each on completion with strata titles being issued to each.

As a result of setting the ball in motion prior to the land purchase then the move from tenants in common to sole proprietor at completion would not normally be subject to the three taxes (although stamp duty is applicable in all states bar WA and NSW).

Furthermore if each had the intention to keep their property as a long term investment then there would be no need to register for GST (although this means forgoing GST credits during construction).

Incidentally, there are a number of useful ways to streamline and improve the administration of the project, for example a single party can be the ‘spokesperson’ to the bank and borrowing can be improved through a larger initial cash injection (this is not a deposit).

Unfortunately a superfund could not be party to this joint venture. As mentioned above the superfund cannot buy land and then build if using debt. This is because the single acquirable asset would be the land and it cannot then be used as security to borrow and build.

A superfund could however buy a property “off the plan” but then the three taxes would be triggered. The superfund would pay stamp duty on the purchase price and the seller would need to pay tax on any profits made as well as GST. If the superfund is associated with any of the parties involved in the development then additional complexities arise and these would need to be investigated further.

There are a number of options to consider when developing property that can help reduce risk and improve project viability but my advice is that these strategies need to be determined prior to any purchase. Also if there is any question of doubt in your mind then you should seek professional advice from a specialised property accountant, which I would recommend regardless. 

I wish you luck.

  • Answer provided by Ken Raiss, Chan & Naylor

Top Suburbs : coburg north , willoughby east , midland , murdoch , darlington

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Comments
  • Megan F says on 24/08/2012 04:14:17 PM

    Great article Ken. Could you explain your comment below a bit more?

    Federal taxes and state taxes are triggered on the sale or transfer of the trust units or the completed properties. If the investors were part of the original development (rather than a purchaser) then the three taxes (being income tax, GST and stamp duty) would not necessarily be triggered.

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