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In this duplex development brainstorming session let’s talk about the tax implications of duplex developments.
Duplex Development Brainstorming
What happens taxwise if you develop duplexes on a site that was a main residence until now? When does the main residence exemption stop?
These are just some of the questions Andrew Henshaw of Velocity Legal in Melbourne will discuss with you in this episode.
Here is what we learned but please listen in as Andrew explains all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a free podcast app on your mobile phone.
Brainstorming Duplex Development
Let’s use the example from the last episode 326 about tax deducting your home loan. In that episode Bill had bought a main residence in Darwin for $200k, lived in it for a few years, then moved to Perth for a few years, and then came back. That is the example from the last episode which Andrew Henshaw pulled out of TR 2000/2.
But now let’s spin this further. What if Bill then moves out again to build two duplexes (Lot A and B) and then moves back into one of them (Lot A). To what extent can he still claim the main residence exemption and/or tax deduct the interest?
Interest Tax Deduction
Can Bill tax deduct any of the interest while building the duplexes?
He can’t for the half that will be his main residence (Lot A), but he might for the other half he intends to sell (Lot B) thanks to s8-1 as well as the Steele’s case and as long as his property development is on income and stays clear of s26-102. If his property development is on capital (unlikely but never say never), then the interest for the second half (Lot B) would go onto his capital cost base.
Steele’s Case
The Steele’s case says that interest can be deductible even if that outgoing is incurred before producing assessable income. It could even be deductible if no income is ever generated from the property.
s26-102 ITAA97
s26-102 limits the tax deduction for expenses associated with holding vacant land. This rule is relatively complex. It intends to prevent certain taxpayers from claiming deductions for landbanking.
s26-102 applies if there is no substantial and permanent structure in use or available for use that are allowed to be lawfully occupied as residential premises, so the cubby house is not enough.
However, there are two main exceptions. The rule doesn’t apply to companies and it doesn’t apply to businesses (for example farmers or property developers). So if Bill’s property development qualifies as a business, he is safe from s26-102 and can claim the interest.
Main Residence Exemption for Lot A
Bill will most likely be able to claim the full main residence exemption all the way through for the Duplex he moves back into (Lot A). He can claim the main residence exemption during the construction period under the indefinite absence rule (or the 6-year absence rule).
Even if he had just purchased the vacant land of Lot A with the intention of building his main residence, he could still treat it as if it was his main residence right from the start.
To be entitled to a full main residence exemption, he needs to use it as his main residence for the entire ownership period.
If he had multiple properties, he could choose which one is his main residence for any given year. And he makes this choice when he lodges his tax return upon sale of a property. You look at the days it was treated as the main residence, you divide it by your ownership period, and whatever the percentage that comes out that’s the percentage of the capital gain that’s disregarded.
Main Residence Exemption for Lot B
The big question is to what extent Bill can claim a main residence exemption for the other half (Lot B). The main problem is that by the time Bill sells the second Duplex that building has never been his main residence. For Lot B you have CGT event K4, which we will cover in the next episode 328.
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So these are some notes about what we learned in this quick brainstorm with Andrew Henshaw. Please listen in as Andrew explains this much better than the few notes we have scribbled down above.
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Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 26 November 2021
Tax Talks spoke to Andrew Henshaw - Director at Velocity Legal - for more details.
