If you are involved in subdividing, selling, or developing your land, it is important to be aware of changes to the Income Tax law.
Section CD1 - Land Sales Deriving Gross Income
Section 67 of the Income Tax Act 1976 taxed profits made from the sale of land in certain circumstances. Section CD1 of the Income Tax Act 1994 is the substitute section and changes the emphasis to deriving gross income from the sale or disposition of land; once derived the gross income is then subject to allowable deductions. The result, subject to adjustment for costs, is then the taxable income.
Categories of land sales included in gross income are:
1. Land which was acquired for the purpose or intention of sale.
2. Land that is sold by a dealer who is in the business of buying and selling land.
3. Land that is sold by a developer who is in the business of developing land or dividing it into lots.
4. Land which is rezoned and sold within ten years of acquisition.
5. Land which is subdivided and sold within ten years of acquisition where the subdivision work is of more than a minor nature.
6. Land which is subject to an undertaking or scheme of major development and subdivision involving significant expenditure on earth works, drainage, supply of amenities etc.
All these categories are dragged into the tax net, however, there are exemptions which remove those sales from gross income. These are found in sections CD1(3)-(7) of the 1994 Act, and are explained below.
Purpose or Intention
Section CD1(2)(a) includes in gross income "Any amount derived from the sale or other disposition of any land if the land was acquired for the purpose or intention, or for purposes or intentions including the purpose or intention, of selling or otherwise disposing of it:".
To be caught with this section your intention to sell must have crystallised at the time of purchase. It is wise to have any financier's records drafted as "Prepared to sell it off at a later date if there is financial pressure to do so" rather than "will sell a couple of acres to reduce the loan". There is no disclosure of intention to sell at the time of the acquisition in the former statement but there is in the latter.
There are two ways to circumvent the purpose or intention taxing provision:
a. Where land is acquired and occupied primarily and principally as premises from which you carried on a substantial business.
b. Few small lots surveyed off soon after acquisition fall into the exemption category. However, you can protect yourself from significant tax cost by ensuring that the value attributed to the lot being subdivided in the agreement for sale and purchase is such that no significant profit is generated when the house and the few acres are sold off. The Commissioner has indicated that a registered valuer's valuation (including a statement from the valuer setting out the methods and reasons for the valuation) is an acceptable method of establishing a value for the lot to be subdivided.
Dealing in Land
If a frequent buying and selling pattern is established, you are not in the business of farming but rather in the business of buying and selling land, and if that is in the nature of an enterprise carried on for profit, then you will be said to be a dealer.
Land which is Rezoned
Land owners who have bought land which is sold or disposed of within ten years at a profit where at least 20% of the profit is due to rezoning.
Rezoning includes:
Changes in a district plan.
Consents in relation to the land.
The removal of conditions, obligations, restrictions, prohibitions, or covenants.
Any change of a similar nature.
The likelihood of any of the above.
To trigger the section, you must sell within ten years of the acquisition and not be liable under any of the other taxing sections. A profit must be generated and 20% of that profit must be because of the zoning change.
Farmland is exempt if it was acquired and used or intended to be used primarily and principally for farming.
Subdivision within Ten Years
Gross income is taxable where there has been a sale of land, and where:
there has been an undertaking or scheme
involving a development or division into lots
the development/subdivision work is not of a minor nature AND the undertaking or scheme is commenced within ten years of the date on which you acquired the land.
The key questions are:
a. The date of commencement, and
b. whether the work undertaken was of more than a minor nature.
It is considered that work will be of a minor nature if it involves only a simple survey plan, inserting half a dozen survey pegs, and the legal work required obtaining some new titles.
If the land has to be fenced, accessed by the creation of a new entranceway, or supplied with services, then you are quickly moving into the category of 'more than a minor nature'.
The date of acquisition is when the purchase contract goes unconditional.
Any Scheme or Subdivision Involving Significant Expenditure
Gross income is taxed if it is derived from the sale of subdivided land where there is a scheme or undertaking which involves;
"…significant expenditure on earthworks, contouring, levelling, drainage, roading, kerbing or channelling or on any other work, service, or amenity customarily undertaken or provided in major projects involving the development of land for industrial, commercial or residential purposes…".
There is no time limit. The ten-year rule does not apply.
Exempt from tax if:
A. Immediately before the subdivision land was occupied or used by you or your spouse primarily and principally for farming or agriculture AND
B. The Commissioner is satisfied that the land sold is capable of being worked as an economic farming unit AND
C. The land sold is to be used primarily and principally in any farming or agricultural business.
So if you have a farm and you subdivide it and the sold land is economic and continues to be used as a farm, tax on the profit does not apply.
Leased Land
Leased land does not meet the test in category A (where you are a landlord, not a farmer), so the exemption is not available where leased farmland is subdivided. Be careful about transferring farmland to a family trust and leasing it back to the farming partnership if you are going to subdivide the land. Be careful about selling subdivided land to a trust which then leases it back to you. The purchaser will be a landlord, not a farmer.
Economic unit
To satisfy exemption B, the land must be capable of being an economic farming unit at the time of sale. One of the latest cases, O'Toole v Commissioner of Inland Revenue (1985) 7 NZTC 5,045, states that economic means capable of yielding a reasonable standard of living for its owner without him or her having to resort to secondary employment and after making due return on the capital invested.
Purchaser must farm
Test C is that the subdivided land must be sold for the purpose of farming or agriculture and accordingly any sale will need to have the agreement of the purchaser to use the land in that way if the total exemption is to apply. There appears to be no time frame to that. Previously purchasers have been bound to farming the land for at least a year from the settlement of the sale and purchase. Hopefully that is enough time to comply with the exemption.
The tests are conjunctive. Make sure you satisfy all three.
If you want to subdivide land which you have not owned for ten years and the subdivision will involve more than the most rudimentary survey and legal work, then prior to the development, the land should be sold at full market value to a company which then subdivides and sells and is wound up. The difference between full market value and the sale price of the lots less all costs will then be the gross income which is taxable. Tax in that situation may at least be contained and does not include the inflated value from the time of the original acquisition by the client. The company is wound up on completion of the sale of the subdivided lots so that any associated person of the company is not tainted as associated with the developer. The developer doesn't exist.
Compare that to the position where you are caught with no exempt gross income under any of the first six classes of sale listed previously. In those cases there is a tax on any increase in the value of the land between acquisition and sale, and the Commissioner is free to determine the cost of the land if he is not satisfied with the original cost. Government value normally applies and often that can mean a larger taxable gain.
Where there is to be a subdivision involving significant expenditure, you should obtain an up to date valuation of the land immediately before commencement of the scheme. If a sale to a company is made, watch for depreciation clawback.
Copyright The Lawlink Group Ltd 2001
Every effort has been made to ensure that this information is accurate. However, it is general introductory information only. It does not constitute legal advice and should not be relied on as such. Specialist legal advice should be sought in particular matters. Any reference to law and legislation is to New Zealand law and legislation.
Murray Hill is a partner with the Tauranga Lawlink firm of Sharp Tudhope.
Web site
Sharp Tudhope
Email: murray.hill@sharptudhope.co.nz
Section CD1 - Land Sales Deriving Gross Income
Section 67 of the Income Tax Act 1976 taxed profits made from the sale of land in certain circumstances. Section CD1 of the Income Tax Act 1994 is the substitute section and changes the emphasis to deriving gross income from the sale or disposition of land; once derived the gross income is then subject to allowable deductions. The result, subject to adjustment for costs, is then the taxable income.
Categories of land sales included in gross income are:
1. Land which was acquired for the purpose or intention of sale.
2. Land that is sold by a dealer who is in the business of buying and selling land.
3. Land that is sold by a developer who is in the business of developing land or dividing it into lots.
4. Land which is rezoned and sold within ten years of acquisition.
5. Land which is subdivided and sold within ten years of acquisition where the subdivision work is of more than a minor nature.
6. Land which is subject to an undertaking or scheme of major development and subdivision involving significant expenditure on earth works, drainage, supply of amenities etc.
All these categories are dragged into the tax net, however, there are exemptions which remove those sales from gross income. These are found in sections CD1(3)-(7) of the 1994 Act, and are explained below.
Purpose or Intention
Section CD1(2)(a) includes in gross income "Any amount derived from the sale or other disposition of any land if the land was acquired for the purpose or intention, or for purposes or intentions including the purpose or intention, of selling or otherwise disposing of it:".
To be caught with this section your intention to sell must have crystallised at the time of purchase. It is wise to have any financier's records drafted as "Prepared to sell it off at a later date if there is financial pressure to do so" rather than "will sell a couple of acres to reduce the loan". There is no disclosure of intention to sell at the time of the acquisition in the former statement but there is in the latter.
There are two ways to circumvent the purpose or intention taxing provision:
a. Where land is acquired and occupied primarily and principally as premises from which you carried on a substantial business.
b. Few small lots surveyed off soon after acquisition fall into the exemption category. However, you can protect yourself from significant tax cost by ensuring that the value attributed to the lot being subdivided in the agreement for sale and purchase is such that no significant profit is generated when the house and the few acres are sold off. The Commissioner has indicated that a registered valuer's valuation (including a statement from the valuer setting out the methods and reasons for the valuation) is an acceptable method of establishing a value for the lot to be subdivided.
Dealing in Land
If a frequent buying and selling pattern is established, you are not in the business of farming but rather in the business of buying and selling land, and if that is in the nature of an enterprise carried on for profit, then you will be said to be a dealer.
Land which is Rezoned
Land owners who have bought land which is sold or disposed of within ten years at a profit where at least 20% of the profit is due to rezoning.
Rezoning includes:
To trigger the section, you must sell within ten years of the acquisition and not be liable under any of the other taxing sections. A profit must be generated and 20% of that profit must be because of the zoning change.
Farmland is exempt if it was acquired and used or intended to be used primarily and principally for farming.
Subdivision within Ten Years
Gross income is taxable where there has been a sale of land, and where:
The key questions are:
a. The date of commencement, and
b. whether the work undertaken was of more than a minor nature.
It is considered that work will be of a minor nature if it involves only a simple survey plan, inserting half a dozen survey pegs, and the legal work required obtaining some new titles.
If the land has to be fenced, accessed by the creation of a new entranceway, or supplied with services, then you are quickly moving into the category of 'more than a minor nature'.
The date of acquisition is when the purchase contract goes unconditional.
Any Scheme or Subdivision Involving Significant Expenditure
Gross income is taxed if it is derived from the sale of subdivided land where there is a scheme or undertaking which involves;
"…significant expenditure on earthworks, contouring, levelling, drainage, roading, kerbing or channelling or on any other work, service, or amenity customarily undertaken or provided in major projects involving the development of land for industrial, commercial or residential purposes…".
There is no time limit. The ten-year rule does not apply.
Exempt from tax if:
A. Immediately before the subdivision land was occupied or used by you or your spouse primarily and principally for farming or agriculture AND
B. The Commissioner is satisfied that the land sold is capable of being worked as an economic farming unit AND
C. The land sold is to be used primarily and principally in any farming or agricultural business.
So if you have a farm and you subdivide it and the sold land is economic and continues to be used as a farm, tax on the profit does not apply.
Leased Land
Leased land does not meet the test in category A (where you are a landlord, not a farmer), so the exemption is not available where leased farmland is subdivided. Be careful about transferring farmland to a family trust and leasing it back to the farming partnership if you are going to subdivide the land. Be careful about selling subdivided land to a trust which then leases it back to you. The purchaser will be a landlord, not a farmer.
Economic unit
To satisfy exemption B, the land must be capable of being an economic farming unit at the time of sale. One of the latest cases, O'Toole v Commissioner of Inland Revenue (1985) 7 NZTC 5,045, states that economic means capable of yielding a reasonable standard of living for its owner without him or her having to resort to secondary employment and after making due return on the capital invested.
Purchaser must farm
Test C is that the subdivided land must be sold for the purpose of farming or agriculture and accordingly any sale will need to have the agreement of the purchaser to use the land in that way if the total exemption is to apply. There appears to be no time frame to that. Previously purchasers have been bound to farming the land for at least a year from the settlement of the sale and purchase. Hopefully that is enough time to comply with the exemption.
The tests are conjunctive. Make sure you satisfy all three.
If you want to subdivide land which you have not owned for ten years and the subdivision will involve more than the most rudimentary survey and legal work, then prior to the development, the land should be sold at full market value to a company which then subdivides and sells and is wound up. The difference between full market value and the sale price of the lots less all costs will then be the gross income which is taxable. Tax in that situation may at least be contained and does not include the inflated value from the time of the original acquisition by the client. The company is wound up on completion of the sale of the subdivided lots so that any associated person of the company is not tainted as associated with the developer. The developer doesn't exist.
Compare that to the position where you are caught with no exempt gross income under any of the first six classes of sale listed previously. In those cases there is a tax on any increase in the value of the land between acquisition and sale, and the Commissioner is free to determine the cost of the land if he is not satisfied with the original cost. Government value normally applies and often that can mean a larger taxable gain.
Where there is to be a subdivision involving significant expenditure, you should obtain an up to date valuation of the land immediately before commencement of the scheme. If a sale to a company is made, watch for depreciation clawback.
Copyright The Lawlink Group Ltd 2001
Every effort has been made to ensure that this information is accurate. However, it is general introductory information only. It does not constitute legal advice and should not be relied on as such. Specialist legal advice should be sought in particular matters. Any reference to law and legislation is to New Zealand law and legislation.
Murray Hill is a partner with the Tauranga Lawlink firm of Sharp Tudhope.
Web site
Sharp Tudhope
Email: murray.hill@sharptudhope.co.nz
January, 2002
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