The fine line between property development and "merely realising an asset"

There can often be a fine line between whether a person is carrying on property development activities or is “merely realising an asset”

For example, it may not be clear whether the extent of a person’s development activity in respect of, say, subdividing his or her backyard and building one or more units of accommodation and selling them either amounts to property development or merely realizing an asset – and one that has been used mainly for domestic purposes.

And a person may be considered to be carrying on property development activities if they are not in the business of property development and it is a one-off activity.

Suffice to say, the tax consequences between property development and “merely realising an asset” are entirely different.

In the case of carrying out property development activity, the gains are assessable as ordinary income (or as business income) – and, importantly, without the benefit of the capital gains tax (CGT) 50% discount which would otherwise reduce the assessable amount.

However, relevant expenditure incurred is generally deductible as it is incurred, ie, in the income year that it is incurred. And this may be of great benefit to the developer. On the other hand, if a person is “merely realising an asset” then any gain is only accounted for under the concessionally taxed CGT regime (and with the benefit of the 50% CGT discount, if generally the land has been owned for more than 12 months).

Furthermore, in this case, if the property in question was acquired before 20 September 1985, then there will be no consequences (either CGT or ordinary income). And there are still quite a few pre-CGT properties around that are ripe for realisation.

So, how does the Tax Office tell the difference between the two when it is not abundantly clear from the nature of the activity itself?

Well, several factors are particularly important (among the many that can be taken into account).

These include the intention with which the person originally acquired the land. To develop it and on-sell it for a profit? Or merely for some other non-profit purpose? For example, to live in it as their home (although this distinction is getting harder to tell in the current property market!).

Another key factor is the extent to which theperson gets involved in the activity. As a broad principle, where a person is less involved in the activity and merely acts passively it is generally considered to be “merely realising an asset”. But this is not a hard and fast rule.

There are also important GST consequences depending on the nature of the activity and the property involved.

Finally, it should be stressed that just because the nature of the activity is a one-off transaction it does not mean that the person is immune from being taxed on the profits as ordinary or business income.