Are you taxed on income or capital account for your property transactions, and what difference does it make?

There are a number of typical scenarios where “mere realisation” applies:

• A taxpayer selling a main residence or long-term investment property.
• A taxpayer selling an office building or factory used in their business.
• A farmer subdividing and selling off farming land, provided they do just enough preparation of the property to realise the best price possible – and no more.

In this case, the sale is on capital account, with the potential for the 50 per cent CGT discount to apply (if the property has been held for more than 12 months). In addition, other concessions may be available (e.g. the small business CGT concessions, the main residence exemption).

Note that where land is subdivided, this does not itself give rise to a CGT event. Instead, the original cost base of the asset must be apportioned across the subdivided blocks. Where a block of land is subdivided into a large number of lots, which are subsequently sold off, this can still be a mere realisation.

This treatment will not apply where the land is acquired for resale at a profit or for development. For example, the following risk factors should be taken into account, which indicate that the project has gone beyond a mere realisation (capital treatment) to become a property development business or an isolated profit-making transaction (in either case, subject to income tax):

• Introducing a “business structure” to the project, e.g. a corporate entity, to undertake the development.
• Is the involvement of the taxpayer passive or active? The more actively involved in the project, the more likely the Australian Taxation Office will regard the project as a profit-making undertaking or a business.
• Acquiring extra land to add to existing land, with the combined site developed.
• Entering into a joint venture agreement with a developer. Where payments on each lot are based on a pre-agreed land value, this is generally OK and could still indicate a “mere realisation”. However, where payments are a share of profits, this is more likely to be income on revenue account.

A CGT event occurs at the date the sale contract is entered into. If the contract is conditional, this does not affect the time of making the contract unless the condition is precedent to the formation or existence of the contract (in which case, not meeting the condition would prevent the contract from ever coming into existence).

Where the contract date and the settlement date are in a different year, the taxpayer does not need to include the CGT event in the tax return until settlement occurs (though may choose to do so). Once settlement occurs, the taxpayer must go back and amend the tax return for the year the contract was entered into.

Property development business or isolated profit-making transaction

Property developers are in the business of acquiring, subdividing and selling land or acquiring and renovating property with a view to profit. In this scenario, any development profits will be subject to income tax. Key identifying factors that indicate a profit motive include:

• The land is acquired with the purpose of making a gain on resale, or in the course of carrying on a business.
• The taxpayer has a history of developing land or acquiring and renovating property for profit.
• There is extensive work undertaken on land, including installation of drains, construction of parks, lakes, footpaths, roads etc.
• There is a high degree of personal involvement in the development.
• The transaction is carried out in a business-like manner.

Note that the tax treatment of either of these scenarios is quite a bit harsher because none of the CGT discounts, concessions or exemptions applies. However, in situations where the project is loss-making, you might actually prefer to be taxed on revenue account because any losses can be offset against any other income arising in the same or future years, whereas capital losses can only be offset against any other capital gains.

Mark Chapman is the director of tax communications at H&R Block Australia.