If you live on a large block, it can be very tempting to subdivide the block, sell off the surplus land and continue to reside on the part of the block that contains your house.
Given escalating house prices in our big cities, those on the suburban fringes – who often live on bigger blocks, with more land than they actually need or use – often see subdividing as a quick and easy way to make money.
But can subdividing your land cause a tax headache?
Potentially, the answer is yes.
For a start, you need to consider Capital Gains Tax (CGT).
Although subdividing your block doesn’t itself trigger a capital gain because there is no actual disposal of anything, you will need to apportion the amount you originally paid (the “cost base” in tax terminology) of your land between the subdivided blocks.
You’ll need to engage a qualified valuer to undertake that exercise and it is best to get a written report that can then be used to substantiate the split if the ATO later queries it.
When there’s a subsequent sale of one or more of the subdivided plots, CGT may be an issue. If you sell the part on which your home sits, you won’t generally be liable for CGT because of the main residence exemption.
If the part sold is adjacent to or surrounding your home, the main residence exemption typically won’t apply and CGT will be payable based on the difference between the sale proceeds and the cost base (which you’ll have worked out at the time of subdivision – see above).
If you choose to build a house on the adjacent plot and then sell the land with the house, completely different tax rules might apply.
Rather than making a capital profit from the sale of land, the ATO might regard you as having undertaken a profit-making venture, meaning that you could be liable to income tax (not CGT) on the sale and might also have to account for Goods and Services Tax (GST) on the sale proceeds, meaning that you’ll have to register for GST with the ATO and charge GST to the purchaser.
You’ll also be able to claim back the GST you paid in relation to building costs.
Income tax versus CGT
The impact of paying income tax rather than CGT can be mixed.
On the downside, you won’t be able to claim the CGT 50 per cent discount that has the effect of halving the rate of tax normally payable on a capital gain.
On the upside, you’ll be able to claim a deduction for all the costs involved in subdividing the block and constructing the new house.
On balance, most people involved in property transactions prefer to pay CGT because of the availability of the CGT discount but ultimately that’s not a choice you get to make – the type of tax you pay is determined by the facts and if you go beyond simply subdividing your block and move into actively developing your property by building new houses on the spare land, the ATO won’t allow CGT treatment.