Edited version of private ruling

Authorisation Number: 1011600307270

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Ruling

Subject: CGT Event A1 change of ownership interest and rental income and deduction apportionment

ISSUE 1

Question 1

Is there a disposal of asset for the capital gains tax (CGT) purposes if the asset was reassigned between the owners?

Answer

Yes

Question 2

Can the 60/40% valuation break up obtained late 2007 be used as the break up of the original purchase price of the properties between the two properties for cost base purposes?

Answer

No. You cannot use the 60/40% break up. The cost base for the properties will be the acquisition price of both properties at the time of purchase divided equally between you three as the properties were purchased as one property under a joint tenancy agreement giving you all equal interest in both properties.

ISSUE 2

Question 1

On reassignment of title in the properties, will the apportionment of the rental income be calculated based on the change of ownership even if the same tenant still has access to both properties?

Answer

Yes

Question 2

Is the private arrangement of division of the rental income appropriate up to the time of demolition of Property 2 considering that the tenant still had access to the tennis court and the garage that straddled the boundary of both properties?

Answer

No. As there has been a change in ownership interest for both properties, the division of the rental income and expenses will be determined based on the outright ownership interest of each owner at the time of title transfer.

This ruling applies for the following period

Income year ended 30 June 2008

Income year ended 30 June 2009

The scheme commenced on

28 December 2007

Relevant facts

In late 2003, the taxpayer, their spouse and family member purchased two adjoining properties (Property 1 and Property 2) as joint tenants for investment purposes.

The apportionment of the properties on the purchase contract is one third each.

The properties have been rented out as one residential property. Property 1 has the house, Property 2 has the tennis court, and the garage straddles both properties.

Throughout the period of ownership and leasing, the tenant had access to the house, garage and tennis court as part of the lease.

Each year the rental income and deductions have been apportioned equally to the three owners.

Late 2007, the owners decided that a change in title would be effected. The taxpayer and their spouse will have Property 1 and the family member will have Property 2.

A registered valuer was engaged to make a valuation who apportioned the value of the properties as 60% to Property 1 and 40% to Property 2.

There was no money exchange for the legal transfer of title in late 2007.

After the legal transfer, the rental incomes and expenses were still divided equally between the three owners as the tenant had access to the three areas until the demolition of the tennis court and garage.

From the time of demolishment of the tennis court and garage, the rental income is only divided between the taxpayer and their spouse as the tenant only has access to the house.

Property 2 will be developed by the family member separately.

According to our records, the taxpayer has lodged their income tax return and received the notice of assessment for the 2007-08 income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Subsection 104-10(1)

Income Tax Assessment Act 1997 Subsection 104-10(2)

Income Tax Assessment Act 1997 Subsection 104-10(3)

Reasons for decision

Issue 1

Disposal of an asset

You make a capital gain or capital loss if a CGT event happens to a CGT asset: section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997).

CGT event A1 happens if you dispose of a CGT asset that you own to someone else. You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of the law. The time of the event occurs in the time that you enter into the contract for the disposal of the asset: section 104-10 of the ITAA 1997.

The transfer of an interest in property from joint names to individual names results in a change of ownership. As the arrangement results in a change of ownership, CGT event A1 will happen if you change the ownership of your joint property holdings into individual names.

In your case, the transfer of titles occurred in late 2007 to reassign the properties that you jointly own. That is, you and the other taxpayers will no longer own one third of both the properties. The transfer effect is that you and your spouse will be joint owners of Property 1 and your family member is a 100% owner of Property 2. Based on the valuation you received from a registered valuer, the break-up is 60% for Property 1 and 40% for Property 2. There was no exchange of funds for this transfer transaction.

In order to transfer your ownership interests, the following transactions need to occur:

· you and your spouse will transfer your one-third ownership interest in Property 2 to your family member, thus giving him 100% ownership of the property.

· your family member will transfer their one-third ownership interest in Property 1 to you and your spouse, which will give both of you 50% ownership interest in the property.

Of the ownership interest that you and your spouse end up owning outright in Property 1, the one-third you and your spouse's ownership interest will have been retained from the previous arrangement. As both your one-third ownership has not been subject to a change in ownership, no CGT consequences will arise at that time. This portion of your ownership interest will retain the same cost base from acquisition of the properties immediately before the exchange transaction took place in late 2007.

The remaining one-third ownership interest in Property 1 that your family member transferred to you and your spouse, gives both of you outright ownership of the property. They will be deemed to have been acquired by you and your spouse at their market value at the time they were transferred to you. The market value will form the first element of their cost base.

Vice versa, your family member will own outright Property 2 following the exchange transaction. You and your spouse will have transferred your one-third ownership interest in Property 2 to your family member. You and your spouse will be deemed to have disposed of your ownership interest in the property at its market value at the time you transferred them to your family member in late 2007. You will make a capital gain if the market value is greater than the cost base on acquisition of the property. You will make a capital loss if the market value is less than the reduced cost base of the property.

The table below provides an illustration of what happens to you, your spouse and your family member's ownership interests in the properties.

In working out your capital gain or loss, you will only need to consider those ownership interest transferred by you, your spouse and your family member.

Under subsections 104-10(1) and (2) of the ITAA 1997, you dispose of your asset when its ownership changes, and CGT event A1 occurs as a result. Accordingly, when the ownership of a percentage of your property changes, you have disposed of that same percentage of your asset at this time and you need to determine if you have made a capital gain or loss from the transaction.

Including capital gains in your return

Under subsection 104-10(3) of the ITAA 1997, any capital gain arising from the transfer of ownership interest needs to be included in your assessable income for the year ended 30 June 2008 as this is when the transfer of ownership interest occurred. As you have already received an assessment for the year ended 30 June 2008, you will need to apply for amended assessments to include your capital gains or losses in your 2008 assessable income as these arise.

Issue 2

Division of net income or losses between co-owners of rental properties

Taxation Ruling TR 93/32 Income tax: rental property - division of net income or loss between co-owners; refers to the division of net income or loss between joint owners of a rental property. The Ruling only examines the taxation position of co-owners whose activities do not amount to the carrying on of a business. Persons who own two or three rental properties would not be considered to be carrying on a rental property business.

According to TR 93/32, the income or loss from the rental property must be shared according to the legal interest of the owners except in those very limited circumstances where there is sufficient evidence to establish that the equitable interest is different from the legal title.

The equitable interest will only be different if one of the owners shown on the title deed is holding their share of the property in trust for the other party. That is, for example, you would have to show that your spouse or your family member has given up all claims of ownership of theirs or their spouse's one-third share of the properties and is merely holding it in trust for you.

Co-ownership

Co-owners of a rental property will generally hold the property as joint tenants or tenants in common. An important feature of both a joint tenancy and a tenancy in common is the legal interest of the tenant. It is this legal interest, which ultimately determines, among co-owners of property, the division of the net income or loss from the property.

Co-owners of a property who are joint tenants of that property will hold identical legal interests in the property. That is, their interest must be the same in extent, nature and duration. For example, A and B, who each own identical 50% shares in a property are, provided the other requisite features are present, joint tenants of that property.

On the other hand, the legal interest of tenants in common need not be identical. That is, the extent, nature and duration of each co-owner's interest need not be the same. For example, C owns a 30% share of a property while D owns a 70% share of the property. C and D are, provided the other requisite features are present, tenants in common.

Rental income and expenses must then be attributed to each co-owner according to their legal interest in the property, despite any agreement between co-owners, either oral or in writing, stating otherwise.

Taxation Ruling TR 93/32 discusses at paragraphs 27 to 34 FC of T v. McDonald (1987) 18 ATR 957; 87 ATC 4541, where the taxpayer and their spouse owned both legally and beneficially, two strata title units as joint tenants. Both units were rented out. A record of discussion between them stated that net profits would be distributed 25% to Mr McDonald and 75% to Mrs McDonald. The whole of any net loss would be borne by Mr McDonald.

The question in the case was whether an operating loss on the properties was wholly incurred by the taxpayer, or each of them incurred one-half of the loss.

The taxpayer claimed that there was a partnership between himself and their spouse both under general law and under the Act, that the two home units were partnership property, and that the net profit or net loss from the rental activity ought to be divided among them according to the partnership agreement.

It was established that there was no partnership at general law and that the only relevant relationship between the parties was that of co-ownership. Because the parties were joint tenants at law and in equity, the loss incurred in letting the premises should be shared equally with the consequence that the respondent was entitled to a deduction for one-half only of the loss. And lastly, that the private arrangement between the taxpayer and their spouse as to the sharing of profits and losses does not alter or over-ride their respective entitlements for income tax purposes.

Paragraphs 46 and 47 of TR 93/32 provide the following example:

Mr and Mrs Y purchase a rental property. Mr Y contributed 80% of the funds used to purchase the property while Mrs Y contributed 20%. They register their purchase as joint tenants. They also sign a written agreement to share any profits or losses from the property in accordance with their capital contributions, but share interests in the property equally.

Owning and renting out the one property does not amount to carrying on a business. Mr and Mrs Y are not partners at general law although their relationship is treated as a partnership for income tax purposes. Net profits and losses fro the property should be shared in the same proportion as their legal ownership interests. That is, 50:50. Their agreement to share the profits and losses in proportion to their capital contributions is a private arrangement which has no effect for income tax purposes.

In your case, you, your spouse and your family member purchased the adjoining properties in late 2003 as joint tenants. The two properties were rented out as one property as the house was in Property 1, the tennis court in Property 2 and the garage straddled both properties. Late in 2007, you all decided to reassign the properties. That is, you and your spouse will have Property 1 and your family member will have Property 2. The legal transfer of titles occurred in late 2007. Based on the valuation of a registered valuer, the properties were valued at 60% for Property 1 and 40% for Property 2. Due to the tenant still having access to both the properties after the reassignment of titles, you all decided that the income and deduction for the property will remain divided equally between the three of you until the tennis court and the garage straddling the two properties were demolished.

As the titles on the properties have changed, the ownership interests of all the owners have also changed.

However, irrespective of your private arrangement, the division of income and expenses does not alter the fact that for taxation purposes, the division of income and expenses should be divided based on your ownership interest in the properties.

You and your spouse should reflect in both your income tax return 50% of the income and expenses for Property 1 and your family member should reflect 100% of the income and expenses for Property 2 in their income tax return.

Further information on rental properties is available on the ATO website

Amendment of Income tax return for 2007 - 08 income year

According to our records, you have received the notice of assessment for the 2007-08 income year.

As the Tax Office operates under a self-assessment system, it is essential for you to ensure all the correct amounts are reflected in your income tax return to allow a proper assessment to issue. A self-assessment system means the claims a taxpayer makes in their or their spouse's tax return are accepted by the Tax Office, usually without review, and an assessment notice is issued. Even though the Tax Office may initially accept the tax return, the return may still be subject to review at a later time.

Therefore, as your assessment for the 2007-08 income year has issued, an amendment is required to correct the income and expenses reflected in your income tax return. If your spouse and family member have also lodged and received their assessment, they too will have to amend their returns to reflect the correct income and expenses.

You can make this request by completing the 'Request for amendment of income tax return for individuals' form, which is available from the ATO website under 'Fix a problem', then 'Correct a mistake in your tax return'. Alternatively, you can write a letter providing the following details:

· your name, address, phone number and tax file number;

· the year you want to amend;

· the tax return item number and description affected by the change;

· the amount of income or deduction to be added or taken away;

· the relevant claim type code, if applicable;

· an explanation of why the mistake was made and any additional information applicable to the item being changed; and

· a signed and dated declaration - ' I declare that all the information I have given in this letter, including any attachments, is true and correct'.

It is very important that your letter explains the reason for the change, so that we can correctly assess any penalty or interest charge.

If you voluntarily tell us that you made a mistake and an amendment result in you paying more tax, the amount of penalty that may otherwise have been imposed will, in most cases, be reduced.

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