GST and Property (Part 1): Using the Margin Scheme to Increase Profit
If you are registered for GST or required to be registered for GST and you sell a property, even a residential property, you may be required to charge GST.
This can be an issue when selling to a purchaser who is not registered for GST as they cannot claim any input credit, leaving them out of pocket on that amount. It effectively means the price you hope to get for the property will be 1/11th above the rest of the GST free market or you will need to reduce your profit margin to stay competitive.
However you can minimise or even eliminate the need to charge GST when selling the property using the Margin Scheme, the Going Concern Exemption and for our rural clients, the Farming Exemption.
I'll cover the first option today and the remainder tomorrow.
Residential property and the Margin Scheme
Although residential property is normally GST free, it will need to be charged if you are selling a vacant block of land, a newly built house or undertake substantial renovations to a house before re-selling.
Substantial renovations are renovations in which all, or substantially all, of a building is removed or replaced. However, the renovations need not involve removal or replacement of foundations, external walls, interior supporting walls, floors, roof or staircases to be considered substantial. This means it is possible to have substantial renovations without doing any structural work.
To explain the effect of using the Margin Scheme let's use the fictional example of a builder who buys a residential property from someone not registered for GST to renovate and on-sell at a profit. The builder pays $250,000 and then renovates the property spending $44,000 in business purchases before selling at $330,000. In this example the renovations satisfied the test and were classified as substantial renovations. Our builder can purchase and sell under the Margin Scheme if they wish and would be much better off doing so.
Option 1; without the Margin Scheme
Our builder pays full GST, if any, and claims it all as an input credit against the GST inclusive sale price. In our example there is no GST payable on the purchase price however the builder can claim the $4,000 GST on the renovations. The builder then sells for $330,000 inc. GST to a purchaser who isn’t registered for GST. Of the $330,000 the GST component will be $30,000 leaving a profit margin after the input credit of $4,000 of $10,000.
Option 2; with the Margin Scheme
Our builder buys under the Margin Scheme. Again they pay full GST, if any, however under the Margin Scheme you cannot claim a credit on the GST paid in the purchase price. However you can still claim on the GST on the renovations. In our example there is no GST (however if the builder had built a new house on the land and paid GST they would not receive an input credit for that). In the current example when the Builder sells for $330,000 inc. GST and claims the $4,000 on the renovation business purchases the GST component is only charged on the Margin, that is the sale price less the purchase price ($330,000 - $250,000 = $80,000) leaving a GST component of $7,272.73 and a profit of $32,727.27.
| Without Margin Scheme | With Margin Scheme | |
|---|---|---|
| Purchase Price (no GST) | $250,000 | $250,000 |
| Renovations (inc GST) | $44,000 | $44,000 |
| Total | $294,000 | $294,000 |
| Sale Price (inc GST) | $330,000 | $330,000 |
| Profit before GST | $36,000 | $36,000 |
| Add Input Tax Credit | $4,000 | $4,000 |
| Less GST on Sale | ($30,000) | ($7,273) |
| Final Profit | $10,000 | $32,727 |
This is a much better outcome for the builder.
The important thing to remember about the Margin Scheme is you must purchase under the Margin Scheme to be able to sell under the Margin Scheme. So always think about the end result when you purchase a property, particularly if you will most likely sell the property to someone who isn’t registered for GST.
It is also a great reminder to purchase on the Margin scheme when renovating even if you don’t think you will meet the substantial renovations test if the Vendor is not charging GST. In the above example if the builder had bought on the margin scheme and not undertaken enough renovations to satisfy the test they would not have to charge GST on the sale. There is however no loss for them buying under the Margin Scheme just in case as there was no GST to claim on the purchase price anyway.
Later I'll look at how the Going Concern Exemption impacts commercial transactions and the Farming Exemption.