Property features in the affairs of almost all our clients, and it often represents a significant part of their wealth. So we’re naturally on alert for any impact on property from changes to tax law. Parliament passed new laws with effect from 1 July last year that deny deductions for expenses relating to holding “vacant land”, even when it’s held for an income-producing purpose, such as development for sale, or building a commercial or residential rental property.
The reason for the change was that some taxpayers were claiming deductions when not genuinely holding vacant land with an income-producing intent. The solution was simply to pass laws that deny deductions, and save the trouble of having to sift out the phonies. It means yet another element is now added to the myriad of issues relating to holding property that must be considered as part of making informed decisions.
The kinds of expenses denied a deduction include interest, rates, land tax, insurance and maintenance. A deduction is also denied for a loss made on certain residential developments. Nobody undertakes a development expecting to make a loss, but it’s important to be aware of the denial of any tax relief should a loss arise. More on that later.
Certain types of entities are exempted from these changes, such as companies and non-self-managed superannuation funds. The new law mainly affects individuals, self-managed superannuation funds and private trusts – people and places where much of our clients’ property wealth is held.
For those to whom the new laws do apply, there are then some exceptions based on circumstances. These include carrying on a business, primary producers, land leased on an arm’s length basis to a business, and land affected by natural disasters and other exceptional circumstances.
Whilst you can plan for future acquisitions of land, options are more limited for existing landholdings subject to these new laws. The prudent approach is ensure you know where you stand.
The use of the “vacant land” label is misleading. It generally means land with no “substantial and permanent structure” on it. However, if you construct or renovate residential property on the land, it must satisfy additional conditions. If it doesn’t, the land is still regarded as vacant. The additional conditions are that the residential property must be:
These additional conditions will be met if, for example, you acquire land on which to build a house as a rental investment. Your interest and other expenses will no longer be deductible from acquisition of the land and throughout construction. But once it’s completed, occupancy permit issued, and now seeking a tenant, the expenses from then will be deductible.
But let’s say you acquire land with an old house, and intend to demolish it and build two units for sale. You’ll satisfy the first condition, but not the second, as the units are for sale, not rent. It’s therefore still regarded as “vacant land”. The impact of this is noted below.
For most rental investors, expenses denied a deduction will generally be added to the property’s cost base, thereby reducing any future capital gain (which may be concessionally taxed). So, at the very least, there is ultimately some tax relief for those costs. However, if you lose money upon sale, your misfortune is compounded because under existing law those costs are excluded from the property’s cost base when calculating a capital loss. That results in no tax recognition for them at all.
For developments for sale, there is a dividing line between those that amount to carrying on a business, and those that, although a profit-making venture, fall short of the requisite size and scale to be a business. Larger developments that are businesses are exempt from these new rules, whereas those smaller ones are not.
A concerning outcome under these new laws is that a deduction is denied for a loss made on those smaller residential property developments. The reason is the above-mentioned quirk that the land is still regarded as vacant land. Again, no one undertakes a development expecting to make a loss, but the denial of a deduction in the event you do make a loss is now an additional risk factor. This was perhaps an unintended consequence, as there is no tax mischief.
For existing land assets, interest, etc that was deductible last financial year might not be from this year on. The key is knowing where you stand.
For future land acquisitions, the key is planning. For example, where once it was a given that your trust would acquire land, the choice of ownership vehicle should now be a matter for consideration.
It’s all about having the information you need to make fully informed decisions about your property assets. Whilst they often amount to a significant portion of your wealth, the peace-of-mind value from the advice Nexia Edwards Marshall can provide is immeasurable.
The material contained in this publication is for general information purposes only and does not constitute professional advice or recommendation from Nexia Edwards Marshall. Regarding any situation or circumstance, specific professional advice should be sought on any particular matter by contacting your Nexia Edwards Marshall Adviser.