A must read for commercial property investors!
Following on from part 1 of our Property and Taxes - Commercial Property Considerations article, we will be exploring additional tax considerations for commercial properties.
The tax rules surrounding commercial properties are quite complex and often not fully understood. Some of the 'not so straight forward' issues when it comes to tax and commercial properties include:
Changes made to legislation on 1 July 2019 limit the number of deductions that can be claimed for expenses in respect of holding vacant land. Deductions are denied when there is no 'substantial and permanent structure' located on the vacant land.
Costs involved in holding vacant land may include interest costs, rates and taxes, and other maintenance costs. Only costs directly attributable to the land component are affected by these new provisions (i.e. any interest incurred to fund the construction of a building will still be an allowable deduction whilst the building is being constructed).
There are some exceptions to this including (but not limited to) when the entity holding the land is a company, or the vacant land is used in carrying on a business of property development.The deductions are generally denied for vacant land with no 'substantial and permanent structure'. According to the ATO, 'substantial and permanent structures' refers to a building or other structure constructed on the land that is:
- Significant in size or value
- Not incidental to the purpose of another structure or proposed structure on the land
- Not related to, reliant on, or exist to support the use or function of another structure
- Fixed and enduring (not built for a temporary purpose)
For example, the ATO considers a commercial parking garage complex to have a substantial and permanent structure, and therefore any land holding costs relating to the parking garage complex may be claimed as a tax deduction.
LEASE SURRENDER PAYMENTS
Lease surrender payments are amounts paid by landlords who wish to terminate the lease before it expires. Tenants who wish to terminate the lease early may also pay lease surrender payments to landlords as a compensation for terminating their lease early.
How these payments are treated in the hands of the landlord will depend on whether the property is owned as an investor, or in the course of running a business. The general tax consequences from the landlord's perspective for each scenario is outlined in the table below.
|Lease surrender payment made by landlord to tenant||Property owned as an investor||Not tax deductible. Added to the cost base of the property for future capital gains tax purposes.|
|Property owned in the course of running a business||Claimed at 20% per year over five years.|
|Lease surrender payment made by tenant to landlord||Property owned as an investor||Likely to be a capital gain, which may potentially qualify for the 50% capital gains discount|
|Property owned in the course of running a business||Assessable income|
RENT RECEIVED IN ADVANCED
Rental income is generally treated to be assessable on receipt, however this may not always be the case. If a tenant pays rent in advance and the lease or contractual arrangement provides for a pro rata refund of the unutilised portion of rent, then the amount will be assessable to the landlord over the period to which it relates.
TIMING OF ANY TAXING EVENT ON A SALE OF A PROPERTY
There is a misconception that any profit on a sale of a property is always included for tax purposes in the year in which the property settles and the funds are received. This is true only for properties that are held on revenue account. For any properties that are held on capital account, the relevant date to consider in determining which income year the profit on sale is to be included, is the contract date.
For example, if a contract has been signed to sell a property on 30 June 2021, the profit on sale would need to be included in the 2021 income tax return, even if the property settles months later. If the seller signs a contract on 1 July 2021, the profit will only need to be included in the 2022 income tax return, therefore buying themselves an extra 12 months to pay any tax liability on the sale of the property.
GST-FREE GOING CONCERNProperty that is sold as a going concern will be GST-free. This means that the seller is not liable for GST on the sale of the property, and the purchaser will not be able to claim GST on the purchase of the property. However, both the seller and purchaser will be able to claim GST credits on any costs associated with the sale/purchase (e.g. GST is included in legal and commission costs).
Entities will be able to sell the property as a going concern if:
- The sale includes everything that's necessary for the continued operation of the enterprise
- The enterprise is carried on by the seller until the day of sale
- The purchaser is registered (or required to be registered) for GST
- The buyer and seller have agreed in writing that the sale is of a going concern
Why does it matter?
- Timing of cash flow: If the buyer purchases a property for $2,000,000 + GST, the buyer will effectively pay $2,200,000 to the seller only to claim the $200,000 back from the ATO. Depending on the date of the sale and whether the purchaser is registered on a cash or accrual basis, there could be a lag of up to three months before they get the $200,000 back from the ATO. The seller will need to collect the $200,000 and pay it to the ATO when they lodge their BAS.
Stamp duty: Stamp duty is levied on most property transfers. The amount of stamp duty is calculated on the total selling price. For stamp duty purposes, the selling price is the GST inclusive price. If the property was sold for $2,000,000 and not as a GST going concern, the total selling price for stamp duty purposes would be $2,200,000 and the stamp duty in Western Australia would be $107,215. If the property was sold as a going concern, the selling price for stamp duty purposes would be $2,000,000 and the stamp duty in Western Australia would be $96,915. By selling the property as a going concern the stamp duty saving is $10,300. As the selling price increase the stamp duty savings increase significantly.
Tax outcomes for property transactions are often only considered after the event when it's too late to do anything that could help the position of the taxpayer. With the correct planning better tax outcomes can be achieved for all parties.
The material contained in this publication is in the nature of general comment and information only and is not advice. The material should not be relied upon. Please contact your local Moore Australia office to discuss your specific circumstances or case. Moore Australia, any Australian Member, any related entity of those persons, or any of their officers employees or representatives, will not be liable for any loss or damage arising out of or in connection with the material contained in this publication.