Knockdown-Rebuild and the 2027 Negative Gearing Rules: Which Projects Qualify?

Introduction

Knockdown-rebuild is one of the most strategically significant decisions for investors who own developable land. Under the 2026-27 Budget reforms, KDR projects that increase the dwelling count on a site qualify as new builds retaining full negative gearing rights and the existing CGT discount framework. KDR projects that simply replace a single dwelling with another single dwelling do not qualify.

The supply increase test is straightforward in principle but produces complex outcomes at the margin. Investors planning KDR projects need to understand the rules clearly before committing capital particularly given the substantial cost of demolition and construction.

The Supply Increase Test

The test is applied at the site level: count the dwellings before demolition, count the dwellings after construction. If the after-count exceeds the before-count, the new dwellings qualify as new builds for the first investor owner.

The dwelling count is the number of separately occupiable residential dwellings on a single legal title (or contiguous combined titles). Granny flats and secondary dwellings count as separate dwellings if they have their own kitchen, bathroom, and sleeping area, and meet local council requirements for separate occupation.

Qualifying KDR Projects

The most common qualifying KDR scenarios:

Single house → duplex (most common)

Demolish an existing single house. Build two attached dwellings (duplex), each on its own strata title or as joint-title rental units. Dwelling count goes from 1 to 2. Both new dwellings qualify as new builds for the first investor owner.

Single house → triplex or larger

Demolish an existing single house. Build three or more attached or multi-unit dwellings. Any increase in dwelling count qualifies the new dwellings.

Subdivision and rebuild

A large single-house lot is subdivided into two or more lots, with one or more new dwellings constructed. Provided the total dwelling count increases, the new dwellings qualify.

Duplex → triplex

An existing duplex is demolished and replaced with three or more dwellings. Count increases from 2 to 3+. New dwellings qualify.

Multi-unit conversion

Converting a large existing dwelling into multiple separately occupiable apartments (provided the conversion involves substantial construction work that qualifies the new units as newly built) this is a more complex case and may require ATO ruling.

Non-Qualifying KDR Projects

Single house → single (larger) house

The most common non-qualifying scenario: an existing single house is demolished and replaced with a larger or higher-quality single house. Dwelling count remains at 1. The new house does not qualify as a new build for negative gearing purposes even though it is genuinely new construction.

This is the policy choice that has caused the most debate. From a quality-of-stock perspective, knockdown-rebuild of detached homes contributes meaningfully to housing renewal. But from a supply-quantity perspective (the Government's chosen lens), it does not add to housing stock.

Duplex → single house

Dwelling count falls from 2 to 1. Not qualifying.

Multiple units → smaller number of units

Any net reduction in dwelling count fails the test, even if the new dwellings are higher quality or larger.

Borderline Cases

Major renovation without demolition

Extensive renovation of an existing dwelling (without demolition) does not count as a new build the original dwelling persists. To qualify, the project must involve actual demolition and new construction.

Partial demolition

Partial demolition (e.g. retaining a heritage facade with new construction behind) may qualify depending on the extent of new construction. ATO guidance will be needed for specific scenarios.

Site amalgamation

Combining two adjacent single-house sites (with 1 dwelling each, total 2) and constructing 4 new townhouses. Pre-count is 2 (across the combined sites), post-count is 4. Qualifies.

Sequential development

A single site developed in phases (e.g. existing house retained, new dwelling added at the rear, then later both replaced with multi-unit). Each phase is assessed by its own dwelling count change. The final phase qualifies only if total dwelling count rises from immediately prior.

Granny Flats and Secondary Dwellings

Adding a granny flat or secondary dwelling to an existing property is a special case. The rules:

• If the existing property is itself a qualifying new build (e.g. recently constructed), adding a granny flat may extend new build status to the granny flat subject to ATO confirmation.
• If the existing property is established (non-qualifying), adding a granny flat does NOT confer new build status. The granny flat is treated as an addition to existing stock.
• For a granny flat to confer new build status under any scenario, the supply increase test must be met at the site level.

The practical implication: investors hoping to add a granny flat to an existing investment property to capture new build status will be disappointed. The rules are designed to prevent this kind of incremental gaming.

Structuring a KDR for New Build Status

For investors planning a KDR project, several structural considerations affect qualifying status:

• Plan dwelling count increase from the outset. Design for duplex or larger to qualify.
• Council approvals. Confirm zoning permits multi-unit development before committing to demolition.
• Title structuring. Strata titling each new dwelling allows separate ownership and sale.
• Timing. The new build occupation test (≤12 months before first investor sale) applies plan settlement appropriately.
• Documentation. Retain demolition records, building approvals, and certificates of occupancy as evidence of new build status.

Interaction with Grandfathering

A subtle but important interaction: if you own a property at 7:30pm AEST 12 May 2026 (grandfathered) and later demolish it for KDR:

• Your original grandfathered property is gone (demolished).
• The new dwellings constructed are new builds if they meet the supply increase test.
• For non-qualifying KDR (single house → single house), grandfathering may be lost when the original dwelling is demolished and replaced.

The technical detail will be confirmed in legislation. Investors with grandfathered property considering KDR should obtain detailed tax advice before committing to demolition.

For broader context, see new build rules and grandfathering rules.