Knock-Down Rebuild and Negative Gearing After 2027: When It Works (and When It Doesn't)

Knock-down rebuild (KDR) sits in an unusual position under the 2027 reforms. Whether your KDR project qualifies as a new build and therefore retains full negative gearing depends entirely on whether you increase the number of dwellings on the site. Replace one house with one house, and the tax treatment does not change from established-property rules. Replace one house with a duplex, and the entire development qualifies as new-build supply. This article explains the supply-increase test, the scenarios that work and the scenarios that don't.

The supply-increase test

Treasury's factsheet provides a clean illustration: a single existing house is demolished and replaced with a duplex. Pre-development dwellings: 1. Post-development dwellings: 2. Net increase: 1. Both duplex halves qualify as new builds. The supply test is satisfied for the entire development.

The logic flows from policy intent. The Government's purpose in carving out new builds is to incentivise housing supply. A KDR that replaces one dwelling with one dwelling adds zero units to supply so the carve-out should not apply. A KDR that produces a duplex, triplex or apartment block adds units, so the carve-out applies.

KDR scenarios that qualify

• One house → duplex: classic qualifying KDR. Both halves are new builds.
• One house → triplex/townhouse development: three or four dwellings replacing one. All qualify.
• One house → small apartment block: typically permitted in medium-density zones. All units qualify.
• One house → house + secondary detached dwelling (where local planning treats both as separate): qualifies provided the secondary dwelling is genuinely a separate dwelling, not a granny flat ancillary.
• Combining two adjacent lots into a four-unit development: 2 → 4 satisfies the test.

KDR scenarios that don't qualify

• Free-standing house replacing free-standing house: 1 → 1. No qualification. Established-property rules apply.
• Granny flat added to existing house: not a KDR; ancillary structure does not satisfy supply test (see below).
• Major renovation of existing house: not a new dwelling established-property rules continue.
• House demolished, larger house rebuilt: 1 → 1, regardless of size.

Granny flats and secondary dwellings

Granny flats are explicitly excluded from new-build status when added to a property that is not itself eligible. The exclusion targets the obvious workaround sticking a small secondary dwelling on an existing investment property to "convert" it to new build. The underlying planning question (when is a structure a granny flat vs a separate dwelling) is governed by state planning law see our overview of granny flat rules across Australia before commissioning plans.

Where the underlying property is already grandfathered or itself a new build, the granny flat inherits that treatment. Where the underlying property is an established post-2027 acquisition, the granny flat does not rescue it. See our companion piece on granny flats and negative gearing for the detailed analysis.

Practical mechanics: timing and documentation

For KDR to qualify, the development must be completed and the dwellings sold or first leased in their new configuration. Holding the existing house, knocking it down later, and rebuilding is fine but the tax treatment of each phase needs careful tracking:

• Pre-demolition rental income: treated as ordinary residential rental on the existing dwelling
• Demolition costs: capital works, generally added to the cost base
• Construction interest: capitalised during construction, then deductible once income-producing
• First rental of duplex halves: starts the new-build clock; depreciation schedules from completion

Case study: a Brisbane duplex KDR

Sam owns a 700m² Brisbane block with a 1970s house valued at $750,000. He knocks down, builds a duplex for $900,000 (two 3-bedroom halves), and rents both. Settlement of original purchase: 2024 (grandfathered). Completion of duplex: October 2027.

• Annual rent per half: $34,000 → $68,000 total
• Annual deductible expenses including new-build depreciation: $84,000
• Annual loss: $16,000 across both halves

Because both halves qualify as new builds (1 dwelling → 2), Sam claims the full $16,000 against his wage income each year even though completion is after 1 July 2027. Over ten years at his 37% marginal rate, the wage offset is worth approximately $59,200 in immediate tax savings.