How the Property Market Decline Impacts Your Tax Strategy

The dip and decline in property prices is the talk of the town. Going beyond the media attention given to this housing market decline (which does not seem likely to turn around any time soon) how can investors and small business owners poised to enter the market adopt the most profitable and successful tax strategy, when margins are getting slimmer and slimmer?

House prices nose dive…

Its the story of the summer. Almost across the board, the value of developments and property has taken a hit. Former boom markets, Sydney and Melbourne experienced a property prices drop of 0.7 per cent in the four weeks heading into November. Combined, the two heavyweight capitals were down 1.6 per cent on a rolling quarterly basis; their annual declines were 7.4 per cent and 4.7 per cent respectively. This is worst drop in prices Sydney has seen in almost 30 years. After years of solid growth in value and the flood of foreign investment, few are predicting that this will turn out to be merely a short-term dip. Fall out from the banking royal commission and expectations of a shrinking economy mean investors and home owners should expect to manage this loss in value over the coming years, not months.

So how can investors react?

To measure the reaction of developers in light of this housing market decline, its prudent to first look at the context of how investors and developers have approached the market previously. Typically, budding investors and developers who purchased land or property are faced with the feasibility stage. This involves targeting a peice of land or property and performing feasibility in order to attain council approval for your proposed development, which includes the submission of a plethora of documents and information – plans, drawings, certifications, environmental reports, traffic reports, and so on. Any developer knows that this is an onerous process, whether you wish to buy a block of land and divvy it up for sale or if whether you intend to knock down an existing house and put up a block of flats.

Inherently, there is risk. If you buy land or a house and do not recieve approval, then you suffer a loss. How will this impact your bottom line? How long will the approval take, and will this delay impact your cash flow? How will fluctuations in housing market prices during this feasibility stage impact the value of your investment? (This latter question is all too relevant in light of the current slide in value). Most developers will look to a option agreement to help address these concerns. This allows you to put down a deposit on your property purchase and pay the remainder in a year pending approval by the council.

In the current environment of near-plummeting prices and doom and gloom, this approach has shifted. Developers and investors are weighing up their options differently. It is now all too likely that you will buy land and hold off on taking the risks of feasibility altogether. This is partly because any delay in gaining council approval is very likely to occur while the value of your investment declines, and also because if and once the council does approve your development plans, the actual costs of construction are significant indeed. In a booming market of rising value, this cost of construction is offset by the rise in value. But now, with prices falling, investors are more inclined to hold off on developments and keep their property as stock, looking to retain value over time.

Other investors are likely, of course, simply to avoid buying property in the first place. In either circumstance, this new caution has consequences on the market. Firstly, there will likely be a drop in construction activity, and secondly a decrease in the purchase of property (even though prices are declining). Perhaps even more significantly, for those investors who have developed land or housing, or are holding off and keeping land or housing as stock, or who have entered the feasilibility stage, the current market means they are staring at narrow profit margins after all the money they have invested. How can you adopt a tax strategy in this environment that doesn’t add to your pricing woes and overall loss in value?

A tax strategy that works in a declining property market

A smart property tax strategy largely revolves around the GST. First of all, the GST Margin Scheme allows for a reduction in GST paid by developers. Considering the cost of development in Australia, this can be a significant saving. The Margin Scheme sees concessional treatment provided on the calculation of real estate sales (generally on new residential sales). The base amount is 1/11th of the margin, with the margin being defined as the difference between the original purchase price of the property and the sale price. As an example, if you purchased a house for $600,000 and the sale price is $800,000, then the developer will receive a base GST concession of $18,181 (1/11th of $200,000). This adds value to the final profit on the sale.

It’s important to note that the concession only applies on the profit made on the sale. Also, it only applies if the developer hasn’t already claimed back the GST on the purchase. So, its vital that you plan your GST strategy in such a way that you not only make the most of the margin scheme (by evaluating eligibility) but also so that you are aware the real benefit to your bottom line. In the current falling market, margins are thinner. The 1/11th you receive back matters all the more. How does this fit in with your purchasing costs, expected return, and the costs of feasibility and development?

Developers also need to be even more careful about how the GST is paid in this current market. In the past it was the developers’ responsibility to remit the GST, but from 1 July 2018 the government has required the purchasers of newly constructed developments to remit the GST on the purchase to the ATO. This change has occurred because the ATO has been concerned that developers are charging the GST cost in sale prices, but not remitting this cost back to the ATO. Now that profit margins are even thinner, the ATO is rightly likely to be even more concerned that developers will be keeping this GST cost to themselves, and so are likely to be even more scrutinous. In light of other ATO rulings regarding long-term construction contracts, foreign investment and CGT, and more, now is a time to be even more pedantic and precise in your remittance and declarations. It is important to not risk tax audit penalties at a time when profit margins are narrower.

This again brings to the fore the importance of savvy and compliant tax planning that helps you manage shrinking profit margins. On the other hand, if your profit is less, then this does mean you are likely to pay a lesser amount of income tax. How can your income tax planning and your GST and overall property tax strategy dovetail successfully in a manner that helps you have the best possible cashflow as an investor over the next few (quite likely lean) years in the housing market?

How to turn complex questions into definitive plans

It is complex. The further you dig into this issue, the more questions seem to arise, and precise ones at that. This is where outsourcing an experienced CFO purely for the purpose of developing a 2-5 year property tax strategy can pay off handsomely. A virtual CFO team should have experience across the board in managing property for developers and investors, home owners, and commercial real estate managers. By being able to see the big picture and manage the finnicky details with the ATO, council, and other parties, a virtual CFO can ensure that you protect your profit margins and your cash flow in a time when the value of your investments is falling and the economy as a whole is rather uncertain.

What should small business buyers do in the face of falling property prices?

If you run a small business, and you hear news of falling property prices here, there, and everywhere, then before you leap in and decide to invest in a new home or new commercial property you will need to exercise a bit of caution.

Entering the market involves getting a loan. This means, more often than not, approaching a bank. And the banks have consistently been making it tougher for small business owners to borrow money for housing due to the need to accurately declare taxable income. You need to go beyond a Profit and Loss statement and past tax return, or even an accountant’s statement of current earnings and assets, to actually going ahead and putting in your assessment for the current financial year. And the taxable income and assets your declare to the bank need to match that which is declared to the ATO. So this will not only have consequences on how and when you do your tax, but will also mean that you will need to be more consistent in your documentation of your income ane expenditure. For many cash in hand businesses, already facing audit activity targeting their industries and their loan activity, this means leaping into a market simply because of cheaper property prices without proper consideration of the tax consequences is reckless.

Moreover, banks are hesistant to provide generous property loans, and even in a market where prices are falling, this is unlikely to change. Recent APRA changes are not expected to have significant impact on lending. Many lenders expect you to fork out 30% to 40% of the value of the property, with the loan only covering the remainder. Combined with a weak economic outlook which may challenge the sustainability and profitability of many businesses, these hurdles imposed by banks may see many the small business owner who is looking to buy due to lower prices end up failing to attain a loan.

The time is ripe for the best advice

This market presents its challenges, but these challenges can be met with expertise. For both the small business owner who is looking for buy and the developer, the pathway to investing in property should be preceded by an investment in an outsourced CFO. Since the property market is a bulwark of the economy, you would do well to go beyond your usual advisor and accountant since the capabilities of a Virtual CFO are such that they can give you a holistic and integrated way forward to navigate uncertain business landscapes, covering a variety of issues from GST property costs to banking requirement for loans, from export market grants to managing slim profit margins in an economic downturn. And, since you hire these CFOs only for specific tasks and objectives, this is an investment you can control (unlike many property investments in today’s housing market).

Calibre Business Advisory prides itself on its Virtual CFO packages. The expertise and experience of our CFOs cover an extensive range of tax, strategy, and business issues, and have assisted companies in Australia, the Asia-Pacific, and beyond. Contact our Virtual CFOs today for a free consultation to better manage this current housing market decline.

Important Disclaimer: Readers should not act solely on the basis of the material on this page. Items herein are general comments only and do not constitute or convey advice. Legislation and proposals of legislation are also subject to constant change. We therefore recommend that formal advice be sought before acting in any of the areas. This news article is issued as a guide to the readers. Calibre Business Advisory Pty Ltd and its associated entities disclaims any losses that may be incurred as a result of the reader undertaking any action based on this article.