What you need to know before developing property
Eddie Chung from BDO accountants provides the following suggestions for what investors need to understand before undertaking a small development project.
Risk
"If the property to be developed is currently owned by a discretionary family trust and the trust also owns other valuable assets, you should look at strategies to protect the other assets and ensure that the development vehicle is a separate entity," Chung advises.
"Also, if an individual owns significant assets, it may not be prudent to appoint the individual as a director of the development company as it may expose the director’s personal assets to potential claims."
Return
"If the borrowings will be in your name and the developer is essentially being 'free carried', your return should reflect the extra risk you assume by carrying the debt," Chung says.
"Also, as you own the property, there will be inherent risks associated with your ownership, which should also be factored into the profit and risk sharing arrangement."
Funding
"If you use the loan funds to initially pay down the loan on your private residence and redraw the funds from the home loan to fund the development expenses as they are incurred, the interest on both the development loan and home loan will need to be apportioned for tax purposes," Chung notes.
"As the bank is usually the primary secured creditor behind the project, it will be important to limit its recourse against your personal assets as much as practicable."
Structure
"If you don't wish to be liable for acts done by the developer, you'll need to ensure that you and the developer are not parties to a common law partnership," Chung says.
"The absence of a common law partnership doesn't necessarily mean that there is no partnership for taxation purposes. In fact, the income tax and GST law specifically broaden the definition of a 'tax partnership' to include arrangements where parties are jointly in receipt of income."
Ownership
"If a partnership is established and you're the landowner, you'll need to be careful that the formation of the partnership doesn't inadvertently cause you to dispose of some of your interest in the property," he says.
"Under an unincorporated joint venture, you as the landowner may continue to own the property in your name and enter into a joint venture agreement with the developer. Rather than having a direct interest in the property, the developer will merely be rendering property development services to you in return for a bundle of fees."
Taxation
"If the property developer borrows money in their own name to fund the development project, you as the landowner won't be able to directly claim a tax deduction on the interest," Chung says.
"The tax costs of a project may also be affected by the type of entities used in the structure. For instance, if a unit trust is used to undertake the development project, the unit holder should perhaps be a discretionary trust, which has the flexibility of distributing any income from the unit trust to an entity that pays tax at a lower marginal tax rate."
Exit strategy
"It's important to provide an exit strategy so that the parties may bring the arrangement to an end without bringing about unintended commercial and taxation outcomes," he says.
Source: Eddie Chung, partner, BDO (QLD) Pty Ltd
