Subdividing the Family Property – Income or Capital? 

With rising cost of living pressures putting the crunch on families, and value of property seemingly on an endless rise, it can be attractive for land-rich families to subdivide their property and sell the unneeded blocks for a healthy profit. This can provide much needed cash-flow without the need to sell your entire property. 

However, the tax consequences of doing so are not straightforward and can leave you with a nasty unexpected tax bill. 

We typically see three scenarios: 

1. An existing main residence property is demolished, the land is subdivided, two new houses are built, and one is sold; 
2. Land with an existing main residence is subdivided, a new home is built on the vacant land (with the main residence remaining intact), and the new home and subdivided land is then sold; or 
3. Land with an existing main residence is subdivided, and the new vacant block is sold, with no construction work occurring. 

How each of these scenarios is treated from a tax perspective is different and requires a consideration of some fundamental underpinnings of tax – whether the sale is capital or income. 

Do you need assistance in the sale of your property? Call us on 1300 654 590 or email us.

The revenue vs capital distinction

Broadly, any form of ‘profit’ can fit one of three main descriptions based on how the asset being sold was held: 

1. The asset was ‘trading stock’, being acquired, held and then sold in the ordinary course of business; 
2. The asset was a ‘revenue asset’ being sold as part of an isolated or ‘one-off transaction’ that was entered into with a profit making intention; or 
3. The asset is a ‘capital asset’, being sold as a ‘mere realisation’ of a long-term investment. 

If the land is considered to be trading stock or a revenue asset, then the profit from disposal will be subject to ordinary income tax at full marginal rates. However, if the land is a capital asset, then the gain will be subject to capital gains tax and possible benefit form the general 50% CGT discount. 

To maximise tax benefits from subdividing your property, call us on 1300 654 590 or email us.

Trading Stock

In determining whether an asset is held as trading stock, the main question is whether it is held as part of a business. The term business is defined very broadly in the Income Tax Assessment Act 1997 (ITAA 97) and does not provide much guidance. Instead, we need to look at case law to determine when a business is carried on.  

In Ferguson v Federal Commissioner of Taxation (1979) 9 ATR 873, it was found that, when seeking to identify whether a business has been carried on, regard must be had to the following criteria: 

1. The nature of the activities; 
2. Repetition and regularity of the activities; 
3. Organisation of activities in a businesslike manner; 
4. The keeping or books, records and the use of system; and 
5. The volume of operations and the amount of capital employed. 

The ATO has made use of these factors in Taxation Ruling 97/11. 

Revenue Asset

A ‘revenue asset’ is an asset that is purchased with a profit making intention. Importantly, it is not necessary to identify a ‘business’ associated with the profit.  

The relevant test to determine a profit making intention is discussed in the Myer Emporium Case, which requires that: 

1. The intention or purpose of the taxpayer in entering the transaction was to make a profit or gain, i.e. profit-making scheme; and 
2. The transaction was entered, and the profit was made, in the carrying out of a business operation, commercial transaction, or a ‘venture’ in the nature of trade. 

TR 92/3 identifies several factors that are relevant to determine whether an isolated transaction amounts a profit making scheme: 

1. The nature of the entity undertaking the operation; 
2. The nature and scale of other activities undertaken by the taxpayer; 
3. The nature of the property; and 
4. The timing of the transaction or the various steps in the transaction.  

Essentially the difference between holding trading stock and a revenue asset essentially comes down to a lack of regularity in the activity giving rise to the profit. 

Capital Asset

This contrasts with a capital asset, which is an asset acquired for long term investment. The courts have typically struggled to define appropriately what a capital asset is, but have considered that capital is similar to a tree that produces fruit. The capital asset is purchased for the income that it will bear.  

Broadly speaking, the sale of a property is said to be a ‘mere realisation of an asset’ (and is not ordinary income) if the property was not trading stock or a revenue asset, as described above. The courts have distinguished between these types of assets and capital assets that have been prepared so that they can be realised for the best price possible (and no more).  

Scenario 1

Returning to our scenarios, consider the example where an experienced property developing family decides to demolish their dwelling, subdivide their land and build two units. 

In this case, you would likely run up against the ATO who would claim that property development is in the normal and ordinary course of your business, and that you are undertaking this development with sophistication and skill. 

While you might argue that perhaps it is an entity controlled by you that undertakes the property development business, the ATO and the courts have been attacking this concept. In Doyle and Commissioner of Taxation (Taxation) [2020] AATA 345, the taxpayer controlled many trustee companies (as ‘special purpose vehicles’ for acquiring and developing land) that comprised the ‘Doyle Group’. The court found that there was a single individual who was the ‘controlling mind’ of the group and who took a hands-on approach to managing the entities. The intention of the individual was imputed to each entity within the Doyle Group. 

As the controlling minds of the property development business, this ‘intention’ would likely be reflected upon yourself and it would be determined that you are also carrying on a business of property development. 

Accordingly, the units would be considered to be trading stock and subject to income tax as ordinary income, without the benefit of the 50% CGT discount. 

Arguing with the Tax Office? Call us on 1300 654 590 or email us.

Scenario 2

Next, consider an unexperienced but enterprising family that intend to subdivide their backyard and build a home unit on the vacant land, while leaving the main residence intact. 

While obviously not within the normal remit of their business, looking at this development, it is fairly plain that the family have undertaken it to make a profit in a commercial manner. Significant time and money was invested into developing the home unit into such a state that it could be sold for a profit.  

Accordingly, the units would be considered to be a revenue asset and subject to income tax as ordinary income, without the benefit of the 50% CGT discount. 

Scenario 3

Lastly, lets consider where the land is subdivided and the vacant block is sold, with no construction work occurring. 

In this case, minimal effort has been made on behalf of the family to subdivide their property and undertake any development to the property. They are simply preparing the property for sale in order to realise the best price possible. 

A lot of similarities can be drawn between this situation and Statham & Anor v FCT [1988] FCA 463, where, due to ill health and a depressed market, the taxpayer decided to subdivide his farmland and sell the undeveloped blocks. The court found that this was a mere realisation of a capital asset and was not considered an act of carrying on a business or a profit-making scheme. As a result, the proceeds from the sale were treated as capital receipts rather than income, meaning they were not subject to income tax as ordinary income.

However, it is worth noting that: 

• Involvement of the owners was limited; 
• No construction was done on the land; 
• No borrowings were made; and 
• Professional advice was sought. 

How we can help

Determining whether a subdivision would be classed as trading stock, revenue asset or a capital asset is a question of degrees and inches. It can be hard to know where your activities fit into this spectrum.  We haven’t even touched on the further tax aspects of subdividing property, including the main residence exemption and the impost of GST on selling a new block of residential land. Before undertaking any development, it is essential that you know how your activities are going to be taxed.  

For an experienced tax lawyer to review your proposed development or for more information, contact us on 1300 654 590 or email us.

 

The information contained in this post is current at the date of editing – 7 March 2025.