How to pay zero tax on subdividing your Main Residence
Your family home is usually exempt from capital gains tax due to the principal residence exemption. However, when you subdivide your family home, there are tax implications of subdividing the family home.
It can be a costly mistake to assume that any profit you make from selling the subdivided blocks will also be tax-free.
For starters, if you demolish your primary residence for development, you do not have it as your primary residence anymore. If you create a backyard block with a separate title while retaining your main home, the new land or unit is not your residence.
Further, if you develop your family home intending to make a profit, ATO will tax the income as a business and not capital gains. Therefore, GST may also be payable. On the other hand, if you are developing to unlock your capital, you will be taxed on capital gains.
Tax Implications of Subdividing the Family Home CASE STUDY 1
Sam subdivides his 900 sqm principal residence and creates two new titles of new titles of 400 sqm each and 100 sqm of common area. The existing house was in good condition and retained. It cost Sam $40,000 for subdivision and titles, and he has a quote of $180,000 for building a unit on the new block.
Scenario 1: Sam sells both the house and the new block to the same purchaser at the same time.
Sam will pay zero tax on the transaction. Creating the titles in themselves does not complete any taxable transaction until he sells. As Sam has sold both Blocks to the same purchaser, he has effectively sold his principal residence. Arguably, Sam has increased the value of the block by creating two titles but will escape paying any tax on the increased value.
Scenario 2: Sam sells his house and the new land to different buyers. He did not construct a unit on the new block.
Any profit on the house will be exempt from being taxed as it is Sam’s principal place of residence. However, any gains on the sale of the new block will be taxable. Sam’s intention for the development will play an essential role in determining if the gain is a capital gain or business profit. The Capital gain will entitle Sam to a further fifty percent discount and provide a better tax outcome.
Scenario 3: Sam builds a unit on the subdivided block. His wife loves the new unit, and they make it their primary residence and sell the old house.
Sam will pay zero tax on the transaction as the sale of his primary residence is exempt from tax. When Sam sells his new house in the future, it will be partially exempt from the tax from the date he occupied it as his primary residence. Great outcome.
Tax Implications of Subdividing the Family Home CASE STUDY 2
Rob owns a rundown 700 sqm house which is his principal place of residence for ten years. Rob can create two titles from the block, but he will need to demolish the existing house. However, feasibility stacks up, and Rob can unlock significant capital if he undertakes the development.
In this scenario, Ron can use the four-year extension rule, which will allow Rob’s principal residence exemption to continue if he builds a new house:
- within four years of demolition; and
- occupies it as soon as practical; and
- lives in the new home for at least three months
After three months of living in the new house, Rob can sell the house and new land title to the same buyer simultaneously because that is an option. Such a transaction is the sale of Rob’s primary home and is exempt from tax.
The tax laws in this area can be complex and catch you by surprise. Therefore, you should seek expert opinion before subdividing your principal residence as part of your due diligence.
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