Developing or Subdividing Your Family Home: What Tax Applies?
The ATO has flagged rising non-compliance in residential development — from simple backyard subdivisions through to demolish-and-rebuild projects. How the activity is classified determines whether you face CGT only, or a substantially larger income tax bill. Here's how the key scenarios work.
What are the three tax categories for property development?
Every property development involving the family home falls into one of three categories, each carrying very different consequences:
| Category | When it applies | Tax treatment | GST? |
|---|---|---|---|
| Property development business | Repetitive, commercially-organised development activity | Revenue account — sale proceeds assessable as ordinary income; trading stock rules apply; development costs deferred until settlement | Yes — taxable supply |
| Isolated profit-making scheme | One-off transactions entered into with a profit-making purpose | Revenue account — net profit assessable as ordinary income; CGT also applies (capital gain reduced by net profit under anti-overlap rule, s.118-20) | Generally yes |
| Mere realisation of a capital asset | No profit intent at acquisition; limited development activity | Capital account only — CGT rules apply; main residence exemption may apply to reduce or eliminate the gain | No |
The ATO — and courts — look at the facts, not your preferred classification.
Does selling your subdivided backyard as vacant land trigger income tax?
Where you subdivide and sell part of your backyard as vacant land — without building on it — this is typically treated as the mere realisation of a capital asset, provided:
You originally bought the property to live in
You have no prior property development history
The subdivision is relatively straightforward (limited to council requirements)
Only CGT applies. But there is a significant and frequently misunderstood trap:
The CGT main residence exemption cannot apply to a vacant lot sold separately from the dwelling — even if the property has been your home throughout. The exemption only covers adjacent land when it is disposed of together with the dwelling (s.118-165). Selling the lot separately means the entire capital gain is assessable (subject to the 50% CGT discount if the original property was held for 12+ months).
The capital gain is calculated using an apportioned cost base — the original purchase price and subdivision costs are split between the two blocks on a reasonable basis (generally by relative market value where blocks are of unequal value; refer to TD 97/3).
Pre-CGT land: If the original property was acquired before 20 September 1985, the subdivided lot generally retains its pre-CGT status and is exempt from CGT entirely.
What if you build a dwelling on your subdivided backyard lot and sell it?
Building a new home on a backyard lot and selling it — even as a first-time, one-off project — will almost always be treated as a profit-making scheme under TR 92/3. Constructing a dwelling for re-sale has the character of a commercial transaction regardless of whether the underlying land was your family home.
Key consequences:
Ordinary income: Net profit is assessable under s.6-5 in the year of settlement. Development-related expenses (construction costs, subdivision fees, architect fees, interest) are quarantined and brought to account at settlement — they are not deductible as incurred.
CGT also applies: A capital gain must also be calculated. Any capital gain is reduced by the assessable net profit under the anti-overlap rule (s.118-20). A remaining capital gain may be eligible for the 50% CGT discount. Note that the CGT event occurs in the year the contract is signed, whereas the net profit is assessable in the year of settlement — these can fall in different income years.
Main residence exemption: Does not apply to the new dwelling if you never lived in it.
GST: The new dwelling is 'new residential premises' and the sale is a taxable supply. GST registration is required where turnover reaches $75,000. The margin scheme may significantly reduce the GST liability if eligible — and is worth considering early in the project.
When selling a newly built dwelling, the purchaser is required to withhold an amount at settlement and remit it directly to the ATO. Where the margin scheme applies, the withholding rate is 7% of the contract price. This is credited against your GST liability when you lodge your BAS for the settlement period.
What if you move into the new dwelling and sell the original home?
This is the most tax-friendly scenario. Where you build a new dwelling on the backyard, move into it, and then sell the original home, the original dwelling is generally treated as a mere realisation of a capital asset — and the CGT main residence exemption usually applies. Three concessions interact here:
Six-month overlap rule (s.118-140): If you sell the original home within six months of moving into the new dwelling, both dwellings can be treated as your main residence for that period — potentially delivering a full CGT exemption on the original home.
Four-year construction rule (s.118-150): Allows the new dwelling to be treated as your main residence for up to four years before you actually moved in. This extends the main residence exemption on the new dwelling when it is eventually sold — but the same period is then excluded from the exemption on the original home (subject to the six-month overlap rule). The choice to apply this rule does not need to be made until you lodge the return for the year the new dwelling is sold.
Temporary absence rule (s.118-145): If the original home is rented or sits vacant for more than six months after you move out, this rule can extend the main residence exemption on it (for up to six years of rental). However, it prevents the new dwelling from qualifying as your main residence for the same period — which can reduce the new dwelling's future exemption.
The interaction between these three concessions can produce very different outcomes depending on the sequence of events and the choices made. The trade-offs should be mapped out before construction begins — not at tax return time.
What if you demolish your home and build new dwellings for sale?
Demolishing your existing home to build townhouses or multiple dwellings for sale is a profit-making scheme — or possibly a business, depending on scale and involvement. The same income tax, CGT, and GST consequences apply as for the backyard build-to-sell scenario above.
Key additional point: the land value brought into the profit calculation is the market value at the time the property was committed to the scheme — not the original purchase price. This is typically determined by a professional valuer.
The CGT main residence exemption does not apply to the new dwellings unless you actually move into one.
What do recent court decisions tell us?
RRKC v FCT [2026] ARTA 95: A taxpayer with over 30 property activities argued that specific units — built at one address — were intended as long-term rentals and sold only due to marital breakdown. The Tribunal found the broader pattern of activity (constructing, subdividing, renovating, and regularly selling) amounted to a property business. The units were trading stock and the proceeds were assessable as ordinary income.
FCT v Morton [2026] FCAFC 31: Farmland subdivided into 48 residential lots (part of a large staged development) was held to be a mere realisation of a capital asset. The taxpayer continued farming for years after rezoning, played an inactive role in the development (which was managed by a property company), and had never acquired the land with development intent. The Full Federal Court confirmed that engaging a developer does not itself amount to embarking on a business or profit-making scheme.
The line between categories is a question of degree. Key factors: your original purpose, your level of personal involvement, your prior property history, and the scale of the activity.
Frequently Asked Questions
Does the main residence exemption apply if I sell a subdivided vacant block? Generally no — the exemption only covers adjacent land disposed of together with the dwelling. Selling the block separately means the full capital gain is assessable (subject to the 50% CGT discount if held 12+ months).
If I've only done one backyard development, can it still be a profit-making scheme? Yes. A single project involving construction of a dwelling for re-sale is typically treated as a profit-making scheme, even if you've never developed property before.
Is GST payable when I sell a new dwelling I built on a backyard lot? Almost certainly yes, if the sale price exceeds $75,000. New residential premises are a taxable supply. Registering for GST (or backdating registration where available) also allows you to claim input tax credits on construction costs.
Can I claim the 50% CGT discount on a profit-making scheme? The discount may apply to any remaining capital gain after the assessable net profit is deducted under the anti-overlap rule — provided the asset has been held for more than 12 months.
When should I get tax advice? Before you commit to the project. Classification issues, GST registration timing, and the interaction between the main residence concessions all need to be considered early — getting these wrong after the fact is costly and difficult to correct.
This article is general in nature and does not constitute tax advice. Property development and subdivision involving the family home involves complex and fact-specific rules — please contact us before proceeding with any project.