• Acquisition of an overseas rental property

    This fact sheet deals with the circumstance where a taxpayer acquires a rental property, the cost of which is denominated in a foreign currency.

    Example scenario

     

    On 1 February 2005 the taxpayer, a resident of Australia, enters into a contract to acquire a rental property in the USA for a cost of USD200,000.

    A deposit of USD20,000 is paid on the day the purchase contract is entered into, with the remaining USD180,000 to be paid on settlement on 1 March 2005. The relevant exchange rates are as follows:

     

     

     

    1 February 2005

    AUD1.00 = USD0.65

     

     

    1 March 2005

    AUD1.00 = USD0.70

     

     

     

     

    The taxpayer is not in the business of buying and selling rental properties, and operates on a cash basis.

     

    End of example

    Questions

    1.

    Will a forex realisation event occur?

    2.

    What will be the forex gain or loss?

    3.

    How should any forex gain or loss be assessed?

    Will a forex realisation event occur?

    Answer

    A foreign exchange (forex) realisation event 4 (FRE4) will arise upon payment of the deposit on 1 February 2005, and upon payment of the settlement amount on 1 March 2005.

    Reasoning

    On entering the contract on 1 February 2005, the taxpayer will incur an obligation to pay foreign currency of USD200,000. Of this amount, a USD20,000 deposit is paid immediately, with an obligation to pay the remaining USD180,000 on settlement.

    1 February 2005:

    On payment of the USD20,000 deposit, a FRE4 will arise as the taxpayer will have ceased to have an obligation to pay the deposit, and the obligation is incurred in return for the acquisition of a capital gains tax (CGT) asset (subparagraph 775-55(1)(b)(iv) of the Income Tax Assessment Act 1997 (ITAA 1997)). The time of the event is 1 February 2005 (under subsection 775-55(2) of the ITAA 1997).

    1 March 2005:

    When the taxpayer pays the remaining USD180,000 purchase price on settlement, the taxpayer's obligation to pay foreign currency (in return for the acquisition of a CGT asset) ceases, and a FRE4 will arise (subparagraph 775-55(1)(b)(iv) of the ITAA 1997). The time of the event is 1 March 2005 (under subsection 775-55(2) of the ITAA 1997).

    What will be the forex gain or loss?

    Answer

    There will be no forex gain or loss on 1 February 2005. There will be a forex gain of AUD19,781 on 1 March 2005.

    Reasoning

    To determine whether the taxpayer has made a forex realisation gain or loss, subsections 775-55(3) and (5) of the ITAA 1997 require a comparison to be made between:

    (i)

    the amount paid in respect of the forex realisation event happening, and

    (ii)

    the proceeds the taxpayer receives for assuming the obligation, or part of the obligation, worked out at the tax recognition time. The proceeds include non-cash benefits which the taxpayer receives for assuming the obligation or part of the obligation.

    That part of the difference (calculated in Australian dollars) that is attributable to a currency exchange rate effect will be the forex gain or loss.

    The gain or loss on the deposit:

    The AUD equivalent of the USD20,000 deposit paid on 1 February 2005 in respect of FRE4 happening is translated at the exchange rate prevailing on 1 February 2005 (subsection 960-50(6) item 5 of the ITAA 1997).

    On that day, USD20,000 = AUD30,769 (USD20,000/0.65).

    Proceeds of assuming the obligation:

    The tax recognition time used to calculate the proceeds of assuming the obligation, occurs when the taxpayer acquires the asset for CGT purposes (subsection 775-55(7) item 9 of the ITAA 1997). This is when the taxpayer enters into the purchase contract on 1 February 2005.

    The proceeds of assuming the obligation is determined as the market value of the non-cash benefit the taxpayer has acquired in return for incurring the obligation to pay the USD20,000 deposit.

    At the tax recognition time (that is, the time the contract was entered into on 1 February 2005), the market value of the rental property is USD200,000. The proceeds of assuming the obligation to pay the USD20,000 deposit is also USD20,000.

    Translated at the exchange rate applying at the tax recognition time of 1 February 2005, the proceeds of assuming the obligation for the USD20,000 deposit = AUD30,769 (USD20,000/0.65).

    In relation to the USD20,000 deposit, the AUD equivalent of the taxpayer's proceeds of assuming the obligation (AUD30,769) is the same as the AUD equivalent of the amount the taxpayer pays to discharge that part of the obligation (AUD30,769). This is because the taxpayer assumed the obligation to pay the deposit (1 February 2005) and discharged that obligation on the same day (1 February 2005). As there is no difference in these amounts, the taxpayer does not make a forex realisation gain or loss on the deposit.

    The forex gain or loss on the remaining settlement amount:

    The AUD equivalent of the remaining USD180,000 paid on 1 March 2005 in respect of FRE4 happening is translated, under section 960-50(6) item 5 of the ITAA 1997, at the exchange rate prevailing on 1 March 2005.

    On that day, USD180,000 = AUD257,142 (USD180,000/0.70).

    Proceeds of assuming the obligation:

    As mentioned above, the tax recognition time used to calculate the proceeds of assuming the obligation occurs when the taxpayer acquires the asset for CGT purposes (subsection 775-55(7) item 9 of the ITAA 1997). This is when the taxpayer enters into the purchase contract on 1 February 2005.

    The proceeds of assuming the obligation is determined as the market value of the non-cash benefit the taxpayer has acquired in return for incurring the obligation to pay the remaining purchase price of USD180,000.

    At the tax recognition time (that is, the time the contract was entered into on 1 February 2005), the market value of the rental property is USD200,000. The proceeds of assuming the obligation to pay the remaining USD180,000 purchase price is USD180,000.

    Translated at the exchange rate applying at the tax recognition time of 1 February 2005, the proceeds of assuming the obligation for the remaining purchase price is USD180,000 = AUD276,923 (USD180,000/0.65).

    In relation to the USD180,000 remaining purchase price, the AUD equivalent of the taxpayer's proceeds of assuming the obligation (AUD257,142) is different to the AUD equivalent of the amount the taxpayer pays to discharge that part of the obligation (AUD276,923). This is because the taxpayer assumed the obligation to pay the purchase price (1 February 2005) on a different day to when the taxpayer discharged that obligation (1 March 2005).

    The amount paid in respect of the event happening (AUD257,142) falls short of the proceeds of assuming the obligation measured at the tax recognition time (AUD276,923). As the difference between these two amounts is solely due to currency fluctuations, the difference falls within the definition of currency exchange rate effect in section 775-105(1)(a) of the ITAA 1997.

    Accordingly, under section 775-55(3) of the ITAA 1997 the taxpayer has made a forex realisation gain of AUD19,781 on 1 March 2005.

    How should any forex gain or loss be assessed?

    Answer

    If a choice has been made under section 775-80 of the ITAA 1997, the AUD gain will be assessable on revenue account. If no choice has been made, the gain will offset the cost base or reduced cost base of the rental property.

    Reasoning

    If the taxpayer has made a choice under section 775-80 of the ITAA 1997 not to have the 12 month rule in section 775-70 of the ITAA 1997 apply:

    The forex gain of AUD19,781 will be included in the taxpayers assessable income under section 775-15 of the ITAA 1997.

    If the taxpayer has not made a choice under section 775-80 of the ITAA 1997 not to have section 775-70 of the ITAA 1997 apply:

    The forex gain made will be treated in accordance with the table in subsection 775-70(1) of the ITAA 1997.

    The requirements of subsection 775-75(1) item 2 of the ITAA 1997 are satisfied because:

    • the gain is made pursuant to FRE4
    • the obligation, or the part of the obligation, is incurred by the taxpayer in return for the acquisition of a CGT asset
    • subsection 775-55(7) item 9 of the ITAA 1997 has determined the tax recognition time (as detailed above), and
    • the USD180,000 is paid on 1 March 2005, which is within 12 months of the acquisition date of 1 February 2005 of the rental property.

    These factors bring the treatment of the forex gain within subsection 775-70(1) item 2 of the ITAA 1997.

    The result is that the forex gain is not included in the taxpayer's assessable income (under section 775-15 of the ITAA 1997). Instead, it reduces the cost base or reduced cost base of the rental property. The cost base or reduced cost base of AUD307,692 (USD200,000/0.65) will therefore be reduced by AUD19,781.

    Note: The 12 month rule generally provides that the forex gains and losses made in respect of capital assets are treated on capital account where the time between acquisition and payment is less than 12 months. Electing out of the 12 month rule means forex gains will be immediately assessable, and forex losses immediately deductible, to the taxpayer. For more information on the 12 month rule, refer to Foreign exchange (forex): the 12 month rule.

    See also:

      Last modified: 01 Mar 2016QC 18190