Introduction to Property Development Taxation, accounting and structuring issues impact on every stage of a development. While these issues are often pushed to the side or considered a boring aspect of a development, failure to consider their impact can have significant cashflow consequences. If you consider the typical development process: a) Locate a site for development and acquire it you will need an appropriate structure to purchase the property and consider how GST might apply to the transaction; b) Obtain finance for the purchase different structures impact on your legal liability and risk, different structures can be easier to lend to; c) Obtain the necessary approvals for the development you should be able to claim GST credits on expenses during this time, claiming back credits helps your cash flow; d) Undertake the development and construction look to claim GST credits on outgoings quickly, the slower you claim back your credits the more holding costs you pay; e) Dispose of the properties or hold the developed property for investment these two different actions have vastly differing taxation, GST and capital gains tax treatments. f) Have funds available after tax to undertake another development or walk away. Structures for a Development When accountants or solicitors speak about the structure of a development, they are generally referring to the legal structure that owns the property being developed. You need to determine your business structure prior to contracting or otherwise entering into a property transaction. Changes in the underlying ownership of an asset can have income tax, capital gains tax, GST and/or stamp duty consequences. Significant costs may be unnecessarily incurred where sufficient planning is not undertaken in relation to the structuring of a property transaction. Unfortunately there is no one size fits all approach when considering the most appropriate structure for a developer. Instead, a decision on the best structure should be made after considering all of the developer s circumstances and seeking independent advice. Factors to consider when deciding on a structure include: a) Who is involved with the development? b) What kind of development am I undertaking? c) Will additional investors be admitted at a later date? d) Will the developed properties be sold or retained? e) What are the tax implications of selecting one entity over another? There are six typical structures that could be used for property development. The structures used are: i) Individual or sole trader iv) Trust ii) Partnership v) Superannuation Fund iii) Company vi) Joint Venture
The company and trust structures are perhaps the most common structure used by developers. When choosing a structure, the taxpayer should give consideration not only to the taxation issues associated with the entity but also the asset protection that a particular entity may provide. In an increasing litigious environment and uncertain economic times, there is an increasing awareness amongst investors that the ability to protect accumulated assets can be as important and in most cases, of even greater importance, than tax minimisation. GST & Property Development As a developer, it is important to understand how GST applies to property. GST can be applicable at all stages of the development process, from acquisition, to planning, construction and disposal. For an entity to be able to claim GST credits or charge GST on a supply, it must first be registered for GST. This application can be made by your accountant or through the website: www.abr.gov.au. An entity is required to register for GST when it is carrying on an enterprise in Australia and its turnover has met the registration threshold. The registration threshold is $75,000 for a business. That is, if your turnover exceeds $75,000 you are required to register for GST. The turnover threshold does not include proceeds from the sale of capital assets. Capital assets include land, buildings and other investments. Margin Scheme The margin scheme is a concessional method used to calculate the GST payable on the taxable supply of real property. While many developers are aware of the margin scheme few are accurately aware of how it works. The margin scheme is applied at the time of sale of the developed property. However, the ability to use the margin scheme is determined at the time of acquisition. The effect of the margin scheme is that when you dispose of a property, you are able to reduce the GST that would otherwise be payable to the Tax Office to 1/11 th of the margin. The margin is the difference between the end selling price and the original acquisition price of the land from the development, excluding acquisition costs. Taxation of a Development s Profits When determining the amount of tax payable on a transaction, it is critical that you seek advice from your accountant to determine whether the profit from a sale is a capital gain or ordinary trading income.
In some circumstances a developer may be able to make use of tax concessions available on the sale of a property they have built because the gain will be taxed as a capital gain. Whether or not these concessions are available will be determined by the actions of the developer, their intentions and use of the property and the structure they used to carry out the development. INVESTING IN PROPERTY Many people have used investment in property over a long period to assist them to build wealth and assets. The most common form on investment in property is direct ownership using a technique called negative gearing. Negative gearing occurs where the income from the property, being the rent, is not sufficient to cover the costs of owning the property. When considering an investment property, there are three distinct costs of ownership; a) Costs of acquisition; b) Ongoing costs of ownership; and c) Costs of selling. Costs of acquisition include legal fees on the purchase, stamp duty, building and pest inspections and borrowing costs. It is important to note that out of these costs, only borrowing costs are tax deductible, albeit over a period of up to five years. The other costs form part of the cost of the property and will be taken into account in determining any taxable capital gain when the property sells. Ongoing costs of ownership include, but are not limited to, advertising for tenants, commissions paid to an agent, bank fees and interest, council rates, repairs, insurance, body corporate fees and pest control. These costs are the cash costs of ownership costs you will be required to pay out in cash. Importantly, a property investor is also able to deduct, in most circumstances, non-cash costs of ownership such as depreciation on fixtures and fittings in the property and a portion of the construction costs of the property. Costs of selling include advertising the property for sale, legal fees on the sale and any commissions paid to real estate agents. Again, like costs of acquisition, these costs are typically not tax deductible but will be taken into account when determining the capital gain or loss on the sale of the property. When determining the taxable income or loss from holding the property each year, the owner uses rental income and subtracts the costs of ownership, both cash and non-cash. Under current tax law, the loss that the investor incurs on the property can be claimed in their income tax return and effectively used to reduce their income tax. For example, if an individual earning $200,000 owns a rental property and has a cash loss on the property of $10,000 with an additional deduction for depreciation and building write off of $7,000, the total deduction that can be included in their income tax return is $17,000.
Based on this income level, the tax saving in their 2010 income tax return is $7,905. After taking into account the tax saving from the rental property, the cash cost of owning the property during that year is $10,000 (being the cash loss) less $7,905 (being the tax saving) which leaves $2,095. Therefore, using the above example, provided the property increased in value more than $2,095 during the year (ignoring the costs of sale) then the investor is ahead. Importantly, if the investor was on a much lower level of income, say $60,000, then the tax saving will be reduced to $5,355. Meaning that the after tax cost of owning the property has also increased to $4,645. This leads to the golden rule of property investment and negative gearing; Negative gearing in property is all about capital gain When you are negatively gearing a property you are actually losing money. If the property is not increasing in value by more then the net loss, you will end up worse off. The opposite to a negatively geared property is a positively geared property. This is a property which after taking into account the tax savings, actually means that the cash costs of ownership are fully covered and you do end up making a cash profit from ownership. This, when combined with the potential for a capital gain, leads to the elusive Win-Win scenario. INVESTING INTERNATIONALLY The same principles to investing in property in Australia apply to investing in property internationally. Whether your are investing internationally or domestically, the aim of investing in property is to achieve capital growth. Australia has taxation agreements with most developed countries around the world and these agreements establish how the income from investments made by residents of the country will be taxed. If you are considering investing internationally you should request information on how the terms of these agreements could apply to your circumstances. Australian tax residents are taxed on their worldwide income, therefore, if you are considered an Australian tax resident, in most cases it does not matter if your investment is made in Australia, the United States or other countries, the income arising from that investment will still be taxed in Australia. In most cases, the country in which the asset is held will take priority for the levying of tax. Therefore, say an investment is held in he United States, you will most likely need to complete a US tax return and pay any applicable taxes there. In Australia, you will also be required to lodge an income tax return and include your foreign earnings in that return. However, where you have paid tax in another country that has a tax treaty with Australia, you can usually claim a credit for this tax against any Australian tax levied.
For example, if I made $1,000 in the United States and paid $200 tax there, I would still need to include the $1,000 in my Australian tax return. However, if the Australian tax assessed was say $250, I should be able to claim the $200 I paid in the US against this amount. After claiming the credit for the foreign tax paid I would still however by liable for an additional $50 tax here in Australia. As with Australian property losses, in most cases losses from a property held as an investment overseas can be offset against your Australian income. However, in certain cases these losses may be restricted or limited. If you are considering investing internationally, you should seek specialist advice in relation to your circumstances to ensure you comply will all applicable tax legislation. Summary & Disclaimer It is important to keep sight of the reasons as to why you are looking to become a property developer on investor. The process can be daunting but it is just the start. Aligning yourself with experienced advisors will reduce the stress involved with this process and ultimately make the move far easier. The information contained in this report and above is general and nature and should not be treated as professional advice nor should it be relied upon by any party without first seeking professional advice from either Cranstoun and Hussein, William Buck Chartered Accountants or another appropriately qualified advisor to ensure the information is appropriate to their circumstances.