As housing prices across the nation accelerate, land subdivision continues to be a financially attractive avenue for ‘Mum and Dad’ developers.
Unfortunately, the dawn of the DYI developer has perpetuated misconceptions regarding the tax implications of subdivision. One common assumption is that any profits generated from the sale of subdivided blocks of land are either tax-free (because the relevant land is used as the taxpayer’s main residence) or taxed as capital gains. While this may be the result in some circumstances, it will not necessarily be the outcome in many others.
The recent Administrative Appeals Tribunal (AAT) decision of McCarthy v FCT  AATA 1511 is a case in point.
The purpose of profit in property subdivision
In August 2016, the taxpayer and her husband purchased a residential property in Western Australia. In November of that year, the taxpayer lodged a successful application for approval to subdivide the newly acquired land.
At the time of purchase, there was a long-term tenant in residence. The tenant vacated the property in May 2017. Two months later, the house was demolished, the land subdivided, and the two lots subsequently sold.
Notably, the taxpayer and her husband sought no tax advice and had no prior experience in subdivision or property development. They did, however, seek a private binding ruling from the commissioner on the income tax implications of the sales.
The Australian Taxation Office (ATO) ruled that the profits of the sales were assessable as ordinary income, “being an isolated transaction carried out for profit and commercial in nature.” As such, the taxpayer and her husband were required to pay tax on the full profit from the sales rather than 50% of the profit under the Capital Gains Tax (CGT) provisions.
After the ATO disallowed their objection to the assessment, the taxpayer took the matter to the AAT.
AAT upholds ATO conclusion
The AAT upheld the ATO’s assessment, finding that, at the time of purchase, one of the taxpayer’s purposes for acquiring the property was the potential profits to be made from subdivision and sale.
The surrounding facts were contrary to the taxpayer’s position, particularly:
- the acquisition, subdivision and sale of the property within a 12-month period; and
- the inability to provide documentation in support of their contentions.
The tribunal rejected the taxpayer’s claims that the purpose of the acquisition was “to rent the property long term with the option to potentially sub-divide the block some years in the future, should they decide to do so”. Accordingly, the tribunal found that any gain was to be assessed as ordinary income.
Objectively viewed, the purchase, subdivision and sale of the property was a transaction “that a person in business would undertake.” One could reasonably argue that the act of buying and selling property, and nothing more, would fit that description. Unsurprisingly, the AAT decided that the act of purchase, subdivision and sale fell within that scope.
What may surprise many is the tribunal’s comment that the necessary profit-making purpose need not be the sole or overriding purpose to attract the characterisation of revenue, but only a “not insignificant purpose” in the transaction.
Lessons learned: Seeking advice prior to purchase and subdivision
What are we to make of this? Should those contemplating enhancing the value of purchased property and selling it forward be concerned?
The answer is to ensure ‘Mum and Dad developers’ never engage in an undertaking that might be considered “an isolated transaction carried out for profit”.
The McCarthy decision demonstrates the importance of obtaining proper structuring advice prior to purchasing and before any subdivisions of land are undertaken.