Private ruling: Land subdivision with townhouse construction
Published: December 2013
Ruling period: Year ended 30 June 2013 | Year ended 30 June 2014
Date scheme commenced: 1 July 2012

Ruling: Q1: Should the profits from your land development be returned on revenue account? | A1: Yes.

Relevant facts and circumstances: You purchased a residential investment property. Since purchasing the property, you rented the property on an ongoing basis but, at times, have been frustrated with tenants defaulting on rents due, as well as damage to the property, resulting in insurance claims to rectify damage. Due to the ongoing frustrations arising from the above situations, along with the increasing losses sustained from the negative gearing of the property (higher than normal losses due to non-payment of rent), you resolved to sell the property. You were advised to optimise net proceeds, you should give consideration to demolishing the existing residence and constructing other structures, which could be sold or you may retained one as your principal residence. You have engaged a builder to undertake the entire construction process, including development of plans, application for regulatory permits and construction of dwellings. You have no previous experience in property development but see this as the best method of realising the full value of the asset.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5

Reasons for decision: Summary: There are three ways profits from a land sub-division and/or property development can be treated for taxation purposes: (1) As ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock. (2) As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated commercial transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business, which is the commercial exploitation of an asset acquired for a profit making purpose. (3) As statutory income under the capital gains tax (CGT) legislation, (sections 10-5 and 102-5 of the ITAA 1997), on the basis that a mere realisation of a capital asset has occurred. Taxation Ruling TR 92/3 is about whether profits on isolated transactions are of a commercial nature that fall on revenue account. Here, in relation to the disposal of property, paragraphs 9 and 49(g) state: The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property. In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations. Some factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are…if the transaction involves the acquisition and disposal of property, the nature of that property ( Edwards v. Bairstow ; Hobart Bridge 82 CLR at 383). For example, if the property has no use other than as the subject of trade, the conclusion that the property was acquired for the purpose of trade and, therefore, that the transaction was commercial in nature, would be readily drawn… In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135 ( Casimaty ), the legal principles in relation to the subdivision of land were discussed at length. In concluding his judgment that the subdivision of the taxpayer was a mere realisation of a capital asset, Justice Ryan said, at 97 ATC 5152: Nor did the taxpayer undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks. Had he constructed dwelling houses , internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement. [Emphasis added] In your case, the sale of your subdivided land, including the construction of new structures, will be an isolated commercial transaction assessable as ordinary income under section 6-5 of the ITAA 1997. This is because the new structures that will be built (and thus acquired) will have no use other than as the subject of trade (as stated in paragraph 49(g) of TR 92/3). This outcome is affirmed in the judgment of Casimaty , which held the subdivision of land with the construction of dwelling houses is a commercial (business) venture.