When property sales and leases collide - managing risk at settlement

Selling a property with a tenant in place can create unexpected settlement issues. Even where a termination notice has been served, vacant possession may not be guaranteed by settlement. For vendors, purchasers and landlords, understanding these issues early can help avoid disputes, delay and unexpected costs at settlement.

This article covers what vacant possession actually requires, the notice periods that matter for ending a residential tenancy for sale, commercial leasing considerations on sale, and the GST position on the sale or lease of residential and commercial property.

What vacant possession requires

Vacant possession generally requires the property to be free of people and claims to occupation and free of chattels (excluding inclusions under the contract) that materially interfere with the purchaser’s use and enjoyment of the property. It does not require the premises to be entirely empty, minor leftover items are generally de minimis (too trivial to matter).

Common vacant possession issues

• Parties assuming that any leftover items breach vacant possession requirement, when only items that substantially interfere with the purchaser’s use and enjoyment of the property will do so.

• Uncertainty over who (vendor or outgoing tenant) is responsible for make good, and which fit-outs, fittings, or fixtures are to remain.

• Rural or large-scale properties left with rubbish, shipping containers, or equipment beyond what a purchaser could reasonably clear themselves.

• Termination notice timing not aligned with settlement date.

Ending a residential property before sale

A tenant on a fixed-term lease is entitled to stay until the end of the term. The sale of a property does not override this; it only sets the notice period. Notice may be given anytime but the termination date must be on or after the end of the term.

The table below sets out the minimum notice period as required under the Residential Tenancies Act 2010 (NSW).

If settlement is intended before the end of a fixed term tenancy, vacant possession cannot be delivered on the sale ground alone. Vendors would need to either negotiate an early surrender with the tenant or sell subject to the existing lease.

Commercial leases and sale contracts

If your commercial lease is registered, it is important to look at the regulations surrounding such leases. For a sale of land in NSW (including commercial property), the vendor must disclose any existing lease or tenancy in the contract for sale.

Where the sale is subject to a lease, the contract should:

•  state the property is sold subject to the lease; and

•  attach a copy of the lease.

A lease exceeding three years (including any option periods) must be registered to bind a purchaser. A lease of three years or less does not need to be registered, although the parties can still choose to do so.

Retail shops are treated differently. Where a retail lease exceeds three years, the lessor must lodge it for registration within three months of the tenant returning the executed lease.

GST treatment of commercial and residential property

Beyond possession and leasing issues, GST treatment can also affect the commercial outcome of a transaction.

GST is a broad-based tax on supplies. Where a sale is a taxable supply, GST of 10% applies but the vendor can also claim back GST paid on their own related costs, agent fees, legal fees, construction costs etc. This is called an input tax credit. Where a supply is input taxed, no GST is charged, but no credits can be claimed on related costs either.

This is why residential and commercial property are treated differently. Existing residential property is input taxed, new residential property and commercial property are generally taxable. Independent tax advice should be obtained for each particular circumstance to understand the specific GST obligations. The general position is set out below.