Edited version of private ruling

Authorisation Number: 1011650480679

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Ruling

Subject: CGT - inclusion of capital improvement costs while a main residence in the Market Value cost base of the property

Question 1

Can capital additions completed once you moved back into the property be added to the 'Market Value' cost base?

Answer

Yes.

Question 2

Can holding costs (council rates, interest etcetera) paid once you moved back in to the property be added to the 'Market Value' cost base?

Answer

Yes.

This ruling applies for the following period

Income year ending 30 June 2010

The scheme commenced on

October 2009

Relevant facts

The taxpayers (husband and wife) purchased the property in late 1991.

The property was their main residence from the date of purchase until mid 2001.

The property then became a rental property from mid 2001 until late 2004.

The taxpayers had another main residence during this rental period.

The taxpayers then moved back into the property in late 2004 and it was again established as their main residence.

During this subsequent main residence period, capital additions were made to the property.

The property was sold in late 2009.

The taxpayer advised of the total number of days of ownership from the first day the property became income producing and the number of days of the rental period.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 110-25.

Income Tax Assessment Act 1997 Subsection 110-25(2)

Income Tax Assessment Act 1997 Subsection 110-25(3)

Income Tax Assessment Act 1997 Subsection 110-25(4)

Income Tax Assessment Act 1997 Subsection 110-25(5)

Income Tax Assessment Act 1997 Subsection 110-25(6)

Income Tax Assessment Act 1997 Section 110-55

Income Tax Assessment Act 1997 Section 118-110

Income Tax Assessment Act 1997 Section 118-185

Income Tax Assessment Act 1997 Section 118-192

Income Tax Assessment Act 1997 Subsection 118-192(1)

Income Tax Assessment Act 1997 Subsection 118-192(2)

Reasons for decision

Summary

As you satisfy the criterion as explained in this ruling, you can include the cost of the capital improvements and the holding costs of the property to the market value cost base.

Detailed reasoning

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated.

Generally, an individual can ignore a capital gain or capital loss from a capital gains tax (CGT) event (for example a sale) that happens to the ownership interest in a dwelling that is being used as a main residence.

To obtain a main residence full exemption:

§ the dwelling must have been their home for the whole period they owned it;

§ they must not have used the dwelling to produce assessable income; and

§ any land on which the dwelling is situated must be 2 hectares or less: section 118-110.

However, where a dwelling that is a main residence for only part of the ownership period and start producing income, a partial main residence exemption will apply when a CGT event happens in relation to the dwelling: section 118-185.

Section 118-192 specifies a special rule in calculating the capital gain or capital loss for a dwelling that became income producing for the first time. The special rule will apply if:

§ you first used the dwelling to produce income after 20 August 1996; and

§ you would obtain only a partial exemption because the dwelling was used to produce income; and

§ you would have obtained a full exemption if you had disposed of the dwelling just before you first used it to produce income.

A further criterion of section 118-192 is that you are taken to have acquired the dwelling at its market value at the time it first became income producing.

ATO Interpretative Decision ATO ID 2003/1112 Capital gains tax: main residence exemption - dwelling first used to produce income establishes the ATO view on the application of section 118-192.

ATO ID 2003/1112 specifically states that if the conditions of subsection 118-192(1) are met, the taxpayer is taken to have acquired the dwelling at the time they first started using it for income producing purposes for its market value at that time: subsection 118-192(2).

This then indicates that any expenditure incurred during the ownership period before the dwelling became income producing is not taken into account in the calculation of the capital gain or capital loss on disposal of the dwelling.

In your case, you purchased the dwelling in late 1991 and established it as your main residence. The dwelling became income producing in mid 2001 until late 2004 when you made the dwelling your main residence again. You then sold it in late 2009.

Therefore, the first element of your cost base will be the market value of the dwelling in mid 2001.

In your private ruling application, you provided the:

§ the number of days that the property was non-main residence (rental period); and

§ the total number of days of the ownership period from the first day the property became income producing until you dispose of the dwelling.

As you meet all the above criteria, your capital gain or capital loss will be calculated using the following formula:

Total capital gain or capital loss multiplied by non-main residence days, divided by the total number of days in your ownership period.

Capital improvements

To work out the capital gain, you need to determine the cost base of the CGT asset involved in the CGT event: section 110-25. To work out the capital loss, you need to determine the reduced cost base of the CGT asset involved in the CGT event: section 110-55.

There are five elements to the cost base:

1. The first element is the total of the money paid or required to pay in acquiring the CGT asset: subsection 110-25(2)

2. The second element is the incidental costs of acquiring the asset or costs in relation to the CGT event, such as agent's commission, valuation cost or conveyancing: subsection 110-25(3)

3. The third element consists of capital and non-capital costs incurred in connection with the ownership of a CGT asset. Specifically, subsection 110-25(4) states that the third element is the costs of owning the CGT asset you incurred (but only if you acquired the asset after 20 August 1991): subsection 110-25(4). These costs include:

(a) interest on money you borrowed to acquire the asset; and

(b) cost of maintaining, repairing or insuring it; and

(c) rates or land tax, if the asset is land; and

(d) interest on money you borrowed to refinance the money you borrowed to acquire the asset; and

(e) interest on money you borrowed to finance the capital expenditure you incurred to increase the asset's value.

4. The fourth element under subsection 110-25(5) is capital expenditure you incurred for

(a) the purpose or the expected effect of which is to increase or preserve the asset's value; or

(b) that relates to installing or moving the asset.

5. The fifth element includes capital expenditure you incur to preserve or defend your title or rights to the asset: subsection 110-25(6).

Subsection 110-25(5) provides that the fourth element of the cost base of a CGT asset is that capital expenditure incurred to increase the asset's value, provided that expenditure Is reflected in the state and nature of the asset at the time of the CGT event.

ATO Interpretative Decision ATO ID 2001/665 Capital gains tax: Cost base: fourth element of cost base expresses the ATO view on expenditures that can be included in the fourth element of the cost base.

That is, for expenditure to be included in the fourth element of the cost base under subsection 110-25(5), it must be incurred 'to' enhance the value of the asset. It is immaterial whether or not the expenditure in fact enhances the value of the asset.

As long as the improvement expenditure is reflected in the state or nature of the asset, not necessarily in its value, at the time of the CGT event, the expenditure would qualify for inclusion in the fourth element of the cost base.

In your case, you moved back into the dwelling in late 2004 and made it your main residence. During this subsequent main residence period, you stated you made capital additions to the dwelling.

As the capital improvements are additions to the property, this would be reflected in the state and nature of the property when the dwelling was sold.

Therefore, the cost of the capital additions will form part of the fourth element of the cost base.

However, it should be noted that expenditure of a revenue nature, such as repair expenses is not to be included in the fourth element of the cost base. Only expenses which are capital or of a capital nature would be included in the fourth element of the cost base. Expenses of capital nature include improvements, renovations, extensions and alterations and are therefore included as the fourth element of the cost base.

(For distinction between a repair and an improvement, please refer to Taxation Ruling TR 97/23 Income tax: deductions for repairs).

Holding costs

For expenses to be included as the third element of the cost base, the CGT asset must have been acquired after 20 August 1991. As the special rule of section 118-192 applies to your situation, you are taken to have acquired the property as of the date you first used it to produce income, that is, in mid 2001, which is after 20 August 1991. Therefore, you are able to include costs of ownership, such as interest on money you borrowed to acquire the asset and council rates, incurred during the period that the property was your main residence.

However, it should be noted that you are unable to include any expenses in the cost base for which you have claimed a tax deduction or omitted to claim a tax deduction but are still able to do so. This will include expenses incurred whilst the property was let. Furthermore, if you did not make a capital gain on the sale of the property, you are unable to include the costs of owning the property in the reduced cost base.

Conclusion

In conclusion, as you satisfy the criterion as explained above, you can include the cost of the capital improvements and the holding costs of the property to the market value cost base.

Therefore, the total cost base of your property includes:

§ the market value of your property at the time it is first used to produce income as the first element of the cost base;

§ the holding costs as the third element of the cost base; and

§ the costs of capital improvements as the fourth element of the cost base.

(For further information, please refer to Guide to Capital Gains Tax 2009-10 which can be viewed from our website: www.ato.gov.au.)

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