Tax Learnings For New Property Developers

The new tax rules concerning interest deductibility removal and the 10 year Brightline (for existing stock residential purchasers), combined with new planning rules allowing for significant intensification of large site properties, has many investors considering their options to develop land they might already own or even make a move to property development rather than sticking with investment.

As with anything new, there is much to learn before taking a leap of faith.

It’s no different on the tax front. This article seeks to offer up some of the important things new developers need to understand before making the decision to develop or divide land with the purpose of profiting from the sale of the developments.

Land held by a property development entity is said to be held on “Revenue account” for resale and as such, it becomes the stock in trade of any development entity. Investment land is held on Capital account, where it is held for the purpose of deriving rental income rather than resale.

They are chalk and cheese with regards tax.

Whenever a developer sells revenue account land, there is tax payable on any profit derived regardless of where that property may sit on a Brightline timeline.

In section CB15, the income tax act contains an anti-avoidance provision designed to remove the motivation a developer may have to transfer land to associated parties at less than full saleable market value. This provision requires anybody associated to the developer acquiring revenue account land to be perpetually liable for income tax should that land be on sold at any time in the future regardless of whether the associate has acquired it on capital account or not.

This provision makes it difficult to effect tax efficient structuring arrangements if the developer’s agenda is to keep some of the revenue account property as investments  and sell some down for profit. The issue is that all the revenue account land held in the development entity is subject to CB15 and as such, any property sold to an associated party will be perpetually taxable, rather than just subject to the 5 year Brightline status it may have had as a new build purchased by a non-associated party.

There are some strategies to mitigate this but careful planning is required right at the outset with the opportunity to manage these issues lost if settlement has already occurred before the matters are considered. So any development with a split keep / sell agenda you need to be seeking advice early on.

Most developments involving the subdivision of land into lots and or the construction of dwellings for resale will constitute a taxable activity for GST.

An important issue when considering the development of land you might already own is how the sale of this land to a development entity might have a GST impact. Unfortunately, when land is acquired by an associate GST can only be claimed to the extent it was originally charged. So if you paid no GST when the land was originally acquired and you want to transfer the property to a new associated development entity, no GST second good tax credit can be recovered. Despite no GST being claimable, there is still GST payable when the developments are sold down. So often, the decision on whether to transfer land to a new associated development company will require a careful trade off between achieving a capital gain on sale to the vendor entity and relinquishing a GST input tax claim in the purchasing entity.

Even if the development land is being acquired from an arm’s length party a purchaser will need to have a clear understanding of the compulsory zero rating rules that impact all land sales between GST registered parties.

If both buyer and seller are GST registered and the buyer gives an undertaking that they will be using the land in their taxable development activity and won’t be living at the property the transaction must be dealt with on a zero-rated basis, ie the vendor does not pay and the purchaser does not claim. A contract that is “inclusive of GST “ in this context is inclusive of GST at the rate of zero offering no 15% claim to the purchaser. There is a long unhappy line of novice developers who have purchased assuming they could claim 15% GST only to discover the compulsory zero rating rules prevent this.

It is only property acquired from non-associated unregistered parties for use in a taxable activity that now gives rise to a GST second hand good claim.

Its also worth reminding readers that entering the business of property development taints future acquisitions of investment properties with a ten-year hold requirement if these investments are ever to be sold at a capital gain.  Whilst this may be less important now that existing stock residential has a ten-year Brightline period anyway, new build residential investments might otherwise offer a five-year Brightline and commercial investments no Brightline at all. So giving some thought to whether you will want to make any investment acquisitions whilst developing is still an important consideration for those navigating the tainting rules.

Lastly, think carefully about the commercial realities of what you are embarking on. Property development is not an easy game. The learnings are hard won and often expensive. Developers often operate on surprisingly small margins and we are entering a time when construction costs are rising and supply chains are stretched. Throw in the decade long building warranties you owe to your purchasers and a tight finance market with increasing interest rates and you start to realise that some of the realities of development have some large risk factors attached to them that are not always easy to mitigate.

As always, do your homework and take tax and GST advice prior to committing yourself.