The Residual Land Problem
Developers need to understand the tax implications of disposing of land that has been subdivided or developed within 10 years of acquisition, writes Mark Withers.
1 January 2020
If you’re considering subdividing or developing land, you’ll will need to become familiar with section CB12. This taxing provision applies to taxation of a gain on disposing of land when the land has been developed or divided within 10 years of acquisition, and the work involved is more than minor.
Unfortunately, the courts have set the bar very low on the question of what work is minor, meaning that the argument that your work is only minor is typically weak.
There are exemptions when the land being divided is the taxpayer’s residence, or business premises, or a farm where the divided lots are still economic farms, or if the work is designed to enable the taxpayer to derive more rental income from new investment houses.
If however, the purpose of the development is disposal of the lots, the gains are typically taxable.
Timing Is Crucial
Now, the interesting thing to understand about CB12 is that the time you have held the property before subdivision commences is the key issue, not the time you kept the land after the subdivision was completed.
So let’s consider an example, our taxpayer owns a four-unit site and has owned it for two years. He decides to subdivide the land but only wants to sell two of the four sections, preferring to keep two to “do something with down the track”.
Now, our taxpayer accepts that the land is divided within ten years of acquisition and acknowledges the work was more than minor. This means tax is payable on any disposal of the sold lots.
‘From an accounting perspective, the apportionment of the development costs is critical’
But, what is the tax fate of the residual lots? The ones that are kept but were none the less created from the division of land that was divided within ten years of acquisition?
Technically, the land still fits within the taxing provision in CB12. This is what is known as the residual land problem. For a long time there was debate over whether an eventual sale of such lots would be taxable, simply because of the original division occurring within ten years.
Helpfully, IRD have recently clarified their view of this dilemma and have stated that the gain on disposal of residual land lots that were not divided off for the purpose of disposal will not necessarily be taxable despite gains on some lots that were sold being taxable.
There are of course provisos around the specific circumstances present in each situation. The IRD have clarified that in determining their view they will consider the following factors.
1. The nature of the original resource consent and any conditions precedent;
2. Any contracts or agreements entered into;
3. Evidence confirming the intended use of the residual land;
4. Whether apportionment of the costs associated with the subdivision was made between lots sold and lots retained;
5. What ultimately happened to the lots; and
6. The reason for the ultimate disposal of the land.
From an accounting perspective, the apportionment of the development costs is critical. If all of the development costs were claimed against the profits from the lots that were sold, it would seem very unlikely that IRD could then be convinced to allow a tax-free outcome when the residual lots are ultimately sold.
Apportionment of these costs is typically done on a square metre basis, but if a more logical method exists flexibility is possible.
An example might be the bridging of a stream that runs through one of the four lots; it would then be appropriate to allocate the cost of the bridge to the lot it sits on.
So the good news is that the residual land problem caused by land being divided within 10 years of acquisition is not necessarily tax fatal if the land is applied to a purpose other than disposal. As always, take expert tax advice when contemplating the development or division of land. ■