Clearly if you are in the business of dealing in land, subdividing or developing land or operate a building business, you appreciate that if you sell something, you are usually going to have to pay income tax on any gain as well as charge GST on the sale price.
Equally, if you acquire something with the intention of selling it, most people appreciate that they may have to pay income tax on any profit they make.
However, what if you are not in a business associated with land and you decide to buy a piece of land and after a period of time decide the land would be worth more if you either developed it a little or cut it up into smaller pieces. You may decide to sell the land or a component of it upon completion of any work, or you may decide to hold on to it for a period of time.
What are you tax obligations in this respect?
The income tax legislation contains a specific section that deals with land transactions. One of the taxing provisions within that section deals with schemes for development or division of land into lots commenced within ten years of acquiring the land.
Important point number one:
You do not have to be in business to have an income tax issue when you sell land.
The basics of the particular provision are:
- You have acquired a piece of land and within ten years of acquiring the land, you commence an undertaking or scheme that involves the development of the land or the division of the land into more lots than originally acquired. Note that for this purpose, the IRD’s current view is that a boundary adjustment will also constitute a division of the land even though no new lots are actually created.
- The work involved in completing the undertaking or scheme is of more than a minor nature. Note that various decisions from the Court have shown that it does not take a lot to breach the minor nature threshold.
Important point number two:
If your undertaking or scheme commences more than ten years after you acquired the land, then you will not be subject to any income tax on the disposal of the land under this specific provision.
In this regard, where you have acquired the land from an associated person, the legislation permits you to use the date that the associated person acquired the land for the purpose of determining whether or not you have breached the ten year rule.
Having commenced your undertaking or scheme within ten years, your next step is to determine whether or not the work involved in completing either the development or the division of the land into lots is of more than a minor nature.
For this purpose you can ignore costs relating to obtaining resource consents from your local council because the Commissioners view is that the relevant territorial authority processes the resource consent in fulfilment of its own statutory functions, and not for the applicant’s purposes.
The IRD released its views surrounding the concept of work of a minor nature in 2005, with the Commissioner stating that the following four points should be considered for the purpose of making any determination:
- the importance of the work in relation to the physical nature and character of the land
- the total cost of the work to be done both in absolute terms and relative to the nature and value of the land when the work has begun
- the nature of the professional services required, and
- the nature of the physical work required for the subdivision (if any).
As we stated earlier in the article, not a lot is required to breach the work of a minor nature threshold.
Important point number three:
The cost of constructing any building on the land is not a cost that should be taken into account when determining the work of a minor nature issue.
Development costs do however include the cost of demolishing any existing buildings on the land as part of your project of development.
Assuming that you have commenced your undertaking or scheme within ten years of the date you acquired the land and that the work involved is of more than a minor nature, you effectively have a taxable event. Whenever you dispose of the land, you will need to declare as income, any profit you made on the sale of the land.
Important point number four:
The legislation effectively prevents you from disposing of the land to an associated party in an attempt to crystallise your income tax liability at a lower value. The associated party will effectively be tainted and will have to pay further income tax on any profit derived when that party eventually makes a disposal of the land.
Once you have a taxable event however, all is not lost as you may be able to claim an exemption.
The first exemption is the residential exclusion. If you undertake the development or division for the purpose of residing on the land by you and your family, then the taxing provision will not apply. Additionally, if the size of the land prior to the commencement of any subdivision was less than 4,500 square metres and the land was occupied by you mainly as residential land for yourself and your family living with you, then the taxing provision will also not apply. Note that this exclusion does not apply where a family trust or a company owns the land.
Important point number five:
Inland Revenue always has the benefit of hindsight. So where you have a pattern of similar transactions over a period of time and you are continually attempting to claim the residential exemption, it is highly likely that Inland Revenue will challenge your position.
The second exemption is the business exclusion. If you undertake the development or division for the purpose and use of carrying on your business from the land, then the taxing provision will not apply.
The third and final exemption is the investment exclusion. The taxing provision will not apply where you undertake the development or subdivision work to create or effect a purpose of deriving rental income and the like from the land. Note that if the land is already being used by you to derive rent, it may be difficult although not impossible to claim the exclusion, particularly if you could perhaps show the work completed enhanced the ability to derive rental income from the land.
Important point number six:
There are no tainting issues under this taxing provision. In other words, other land acquired for non-development/subdivision purposes during the period of your project is not suddenly tainted by your project. Unless that is you have decided to go the next step and be in the business of developing land or dividing land into lots by the time that land is acquired.
The prime issue with any land transaction being considered under the taxing provision discussed in this article, is that the answer is rarely black and white and consequently there is always risk that a determination that you have made that you project is not taxable could be seen differently by Inland Revenue.
With this in mind, if you are contemplating undertaking any land development or subdivision project, you are welcome to contact either Richard Ashby or Colin Tuson in our tax team to discuss the issue. Do not leave it until you are deep in a hole that you cannot get out of.
Final important point:
You need to also consider whether your undertaking or scheme will constitute a taxable activity for GST purposes and consequently have GST implications. Our tax team will be more than happy to answer questions in this respect as well.