Hi Nominees
Consider this:
The property is bought with the intention of redeveloping / ‘substantially’ renovating thus creating a ‘new’ property.
New or ‘substantially renovated’ residential property is a Taxable Supply on sale and it is the vendor’s responsibility to be registered for GST and to collect the tax on behalf of the Government.
So development / renovation gets under way and the owner claims the GST refunds on their quarterly BAS.
So far, so good.
But for whatever reason, the owner’s intentions change. As soon as the property ‘becomes available’ for rent it is a standard residential property. Residential rent is not a Taxable Supply, so all expenses relating to earning that income are input taxed.
However although the rental is not taxed the agent’s commission is.
This continues for a year or two which stretches into five.
From the time of first signing the contract to buy, five years is now effluxed.
So:
For the first eg twelve months the purchase of the property and the expenses involved in it’s subdivision or substantial renovation were considered Acquisitions and the tax on the acquisitions was cash flow refundable 100%.
For the remainder four years the maintenance and any other capital works, and the income generated from the property was input taxed, in other words Purchases and Sales.
The refund on the input taxed expense depends on the whole income of the taxpayer for that tax year as their marginal rate is not known until the end of the year.
So there are two sets of books happening here.
At the five year mark the original twelve months converts so that all of the project becomes Purchases and Sales.
This means that the Acquisitions, which were ‘net of tax’ as the tax had been refunded through the BAS claim in anticipation of the sale of the ‘Taxable Supply’, now has to be added back to the Purchases which are now considered to be input taxed.
So the capital works now become subject to depreciation which can be adjusted against income for that period
And the GST on, say, the Conveyancing fees, has to be added back to the fees and the fees are now amortized over the five years whereas the original scenario was that the fees were capitalized on sale.
Other Income Tax issues are that eg items that were going to be applied to the capital base on sale may now be considered to be ‘maintenance’ and claimable against the income in the year the expense occurred. However, this expense now includes provision for the GST which was previously refunded.
Say a window latch was bought for $1.10 during the Acquisition / Taxable Supply period.
The $0.10 was claimed at the end of the accounting period and refunded.
The $1.00 was posted to the books as a capital expense.
Electricity was used during renovation and the bill was $220.
The $20 GST was claimed and the $200 capitalized.
Interest during this period is capitalized.
Six months later, the property was rented out.
It is no longer a Taxable Supply, and the provision of rent is a Sale which is not subject to GST.
The usual income / expense accounting requirements apply.
So the electricity for security lighting is now an expense. The whole $220 is offset against the rental income at the end of the financial year.
At the end of the five years if the property is still rented out the original window latch can be accounted for as if the property was rented from the beginning.
So:
Expenses for that year do not show the window latch but capitalized it at $1.00
Expenses should have shown the latch as input taxed gross $1.10.
(For someone with a marginal rate the $0.10 tax refund has now dropped to a marginal tax refund of $0.0485. The taxpayer effectively forfeits the $0.051 balance as indirect GST.
So the taxpayer should go back and lodge adjustments for the income tax payable as the net acquisitions have now become input taxed purchases and this most definitely does affect the PAYG and personal levels of tax.
Multiply the above equation by Factor X to achieve the actual figures and you will see we can be talking serious money.
Shall I go on? Do you get my drift?
This has become a logistical nightmare for small developers. Large developers which sell all the stock would not face this problem, but the almost-professional developer would have to be aware of the changing status of the project / investment during the life of the project.
And what happens if the property is rented for, say, years 2, 3 & 4 and sold before the five year mark? The property moves in and out of the tax systems which operate almost like parallel universes.
Unfortunately, there’s not much the individual can do about this except make sure they keep clear and concise accounting records and make specific note of dates when and if the property changes in status.
And no, I don’t go about looking for work for myself. I just try and get a grip on the situation as it stands and as it may become. Myrtle Cottage has morphed from one tax system to another, so has the medical centre. In fact, I can’t really remember why I bought that in the first place – to renovate and sell or to renovate and rent?
And as for the ‘easy way out’, not registering for GST at all:
If you are doing it once, fair enough, but to buy, renovate, sell as a business then it’s very easy to turnover more than $50,000 in a year which is the registration threshold. In fact, it would be impossible not to.
I collected the GST on the sale of the subdivision because although that made the sale very difficult, there was no way I was going to risk my slim profits by being audited and told that I should have collected the GST from the purchaser and if I didn’t then I would have to pay it.
And yes being registered for GST refunds the GST cash as you go, with any potential GST to be collected on sale coming from those future funds.
Now I really do need that cup of tea and where did I put June’s BAS?
Cheers
Kristine
