Edited version of private ruling

Authorisation Number: 1011796157404

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Ruling

Subject: Capital gains tax

Questions:

1. Are you entitled to use a bank valuation to estimate the cost base of property two?

Answer: No.

2. Are you entitled to a partial main residence exemption for property two?

Answer: Yes.

This ruling applies for the following period:

1 July 2009 to 30 June 2010.

The scheme commenced on:

1 July 2009.

Relevant facts:

Since 20 September 1985, you have owned the following three properties:

· property one,

· property two, and

· property three.

Each of these properties is situated on less than two hectares of land.

Regarding property one:

· You acquired property one post 20 September 1985 as a vacant lot.

· You built a dwelling on property one and occupied it as your main residence prior to 1990.

· You entered into a contract to sell property one in xxxx.

· You settled on the contract to sell property one in yyyy.

· Property one was your main residence for a number of years before you moved out of it in yyyy.

· You did not use property one to produce assessable income during any period you owned it.

· When you sold property one, you chose to apply the main residence exemption to it for the whole period of time you owned it.

Regarding property two:

· You acquired property two as vacant land in zzzz.

· You commenced building a dwelling on property two.

· Construction of the dwelling on property two was completed and you commenced occupying it as your main residence in yyyy, immediately after you moved out of property one.

· You 'owner built' the dwelling on property two.

· You did not keep any records of the cost of construction of the dwelling on property two.

· You moved out of property two in aaaa and commenced occupying property three as your main residence.

· Property two was then vacant for a period of time before you commenced renting property two to tenants at a later date.

· You settled on a contract to sell property two in bbbb.

· You wish to use a bank valuation from yyyy as the cost base of property two.

· You jointly owned property two with your spouse.

Regarding property three:

· You became the owner of property three in cccc.

· There was an existing dwelling on property three when you acquired it.

· You commenced occupying the dwelling on property three as your main residence in dddd. This was immediately after you ceased occupying property two.

· The dwelling on property three has been your main residence ever since you moved into it.

· You have not used property three to produce assessable income.

· You will claim the main residence exemption for the full period of time you own property three.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 110-55

Income Tax Assessment Act 1997 Section 118-110

Income Tax Assessment Act 1997 Section 118-125

Income Tax Assessment Act 1997 Section 118-130

Income Tax Assessment Act 1997 Section 118-140

Income Tax Assessment Act 1997 Section 118-145

Income Tax Assessment Act 1997 Section 118-150

Income Tax Assessment Act 1997 Section 118-185

Income Tax Assessment Act 1997 Section 121-20

Income Tax Assessment Act 1997 Subsection 121-25

Reasons for decision

Capital gains tax (CGT)

Real estate acquired on or after 20 September 1985 is a CGT asset.

If you own a CGT asset and a change of ownership occurs from you to another person or entity, you are considered to have disposed of the asset.

In your case, you disposed of property two which was acquired on or after 20 September 1985.

When you dispose of a CGT asset, CGT event A1 happens. In the case of real estate, the time of the event is usually when the contract for the disposal is entered into. If there is no contract, the event occurs when the change of ownership takes place.

When a CGT event happens to a CGT asset you own, you will make a capital gain or loss at the time of the event, depending on whether the capital proceeds from the CGT event are more or less than the cost base/reduced cost base of the CGT asset.

The term 'capital proceeds' refers to the amount you receive, or are entitled to receive from a CGT event.

There are five elements that make up the cost base of a CGT asset. They are:

· The first element: money or property given for the asset.

· The second element: incidental costs of acquiring the asset or that relate to the CGT event.

· The third element: costs of owning the asset.

· The fourth element: capital costs to increase or preserve the value of your asset or to install or move it.

· The fifth element: capital costs of preserving or defending your ownership of or rights to the asset.

The reduced cost base of a CGT asset has the same five elements as the cost base, except for the third element which is a balancing adjustment relating to certain depreciating assets - but not to residential dwellings.

In cases where the CGT asset is land which was vacant when it was acquired and a dwelling is later constructed on that land, the first element of the cost base/reduced cost base is the amount paid to acquire the land. The cost of constructing the dwelling is included in the fourth element of the cost base/reduced cost base.

The CGT record keeping provisions require individuals to keep records of matters relating to any capital gain or loss they make for five years after the date of the relevant CGT event. In the case of CGT assets that are disposed of, the records required to be kept include records relating to:

· the date of acquisition and disposal of the asset,

· each element of the asset's cost base and reduced cost base, and

· the capital proceeds received for the disposal.

Where a CGT asset has been disposed of and the required records have not been retained, you must reconstruct the records or have someone else reconstruct them for you (subsection 121-20(5) of the ITAA 1997). If you cannot reconstruct them, you cannot include the relevant amounts in the cost base of your CGT asset.

Any capital gain or loss made when a CGT event happens to a jointly owned CGT asset must be apportioned to each owner of the asset in accordance with their ownership interest. For example, where two owners of a property each have a 50% ownership interest in the property, 50% of any gain or loss made from the disposal of the property must be attributed to each owner.

If, as a result of a CGT event, you have a net capital gain in an income year, that net capital gain is included in your assessable income and you are taxed on that gain at your marginal tax rate.

Your net capital gain is:

your total capital gains for the year

minus

your total capital losses for the year and any unapplied net capital losses from earlier income years

minus

any CGT discount and small business CGT concessions to which you are entitled.

If your total capital losses for the income year are more than your total capital gains, the difference is your net capital loss for the year.

You cannot deduct capital losses or a net capital loss from your income. However, you can carry forward a net capital loss to later income years to be deducted from future capital gains.

Individual taxpayers are entitled to a 50% discount on any capital gain made from the disposal of a CGT asset if:

the disposal takes place after 11.45am (by legal time in the ACT) on
21 September 1999,

· they acquired the asset at least 12 months before the CGT event, and

· they did not chose to use the indexation method to determine the cost base of the asset.

Using a market valuation as the cost base /reduced cost base of a CGT asset

The 'home first used to produce income' rule is a special rule that can apply in some cases to affect how the cost base/reduced cost base of a CGT asset is determined.

Under this rule, the cost base/reduced cost base of a dwelling that was a taxpayer's main residence and is later used by the taxpayer to produce assessable income is taken to be the market value of the dwelling at the time it was first used to produce income. That is, the original cost base/reduced of the property is substituted for the market value of the property at the time it is first used to produce income.

For the 'home first used to produce income' rule to apply to a particular case, the following conditions must be met:

· you must first start using the home to produce income after 7.30 pm (by legal time in the ACT) on 20 August 1996,

· you must only be eligible for a partial main residence exemption because the dwelling was used to produce assessable income during your period of ownership of the dwelling, and

· a full main residence exemption would have been available if you disposed of the dwelling immediately before it was first used it to produce income.

If all of the above apply, you have no choice but to use the market value of the dwelling at the time you first used it to produce income as the first element of the cost base/reduced cost base of the dwelling.

You have requested that you be allowed to use a bank valuation from yyyy as the cost base of property two, however, you did not commence renting out property two until a later date. The bank valuation is not a reflection of the market value of property two at this later date. Therefore, even if you meet all the conditions required for the home first used to produce income rule to apply to your case, you would not be entitled to use that bank valuation to determine the cost base of property two.

However, if you do meet all the conditions required for the home first used to produce income rule to apply to your case, you would be entitled to use a valuation showing the market value of property two in at the later date as the cost base/reduced cost base of property two.

If you do not meet all the conditions for the home first used to produce income rule to apply to your case the normal cost base rules will apply to property two. That is, if you are unable to reconstruct the cost of constructing the dwelling, you will not be able to include those costs in your cost base for property two.

To determine if you meet the conditions required for the home first used to produce income rule to apply to your case, it is necessary for us to examine the application of the CGT main residence exemption, and the various rules which may limit or extend the application of the exemption, to your situation.

The main residence exemption

The CGT main residence exemption is an exemption that may apply in particular cases to allow individuals to disregard and not include in their assessable income any gain made from the disposal of a dwelling that was their main residence.

Depending on the circumstances, a full or partial exemption may be available when you dispose of a dwelling that was your main residence.

In most cases, to be entitled to a full main residence exemption:

· the dwelling must have been your home for the whole period you owned it,

· you must not have used the dwelling (or the land on which it is situated and adjacent to) to produce assessable income, and

· the land on which the dwelling is situated and adjacent to must be 2 hectares or less.

A partial exemption may be available where any of the above conditions are not met, provided the dwelling has been your main residence for at least part of the period you owned it.

Where you are only entitled to a partial main residence exemption because a dwelling was not your main residence for the whole period of time you owned it, you calculate any capital gain from the disposal of the dwelling using the following formula:

Capital gain x

non-main residence days total days of ownership period

In this calculation:

· The total days of ownership period would be from the date of settlement of the contract to purchase the land or dwelling (or, if the you had a right to occupy the home at an earlier time, from that date) until the date of settlement of the contract for sale.

· The number of non-main residence days is the number of days in the ownership period when the home was not your main residence.

If it is available in respect of a particular dwelling, you make the choice to apply the main residence exemption when you prepare your income tax return for the income year in which the CGT event happens (the year you enter into the contract in the case of disposal of a dwelling).

Rules which may limit or extend the application of the main residence exemption

Generally, the main residence exemption can only be applied to one dwelling at a time, cannot be applied to vacant land, and cannot be applied to a dwelling for periods of time the dwelling is not a main residence. However, the following rules provide some exceptions to these general principles:

· the 'moving from one main residence to another' rule,

· the 'constructing a dwelling on land you already own' rule, and

· the 'absence' rule.

Under the 'moving from one main residence to another' rule, if you acquire a new home before you dispose of your old one, you can treat both dwellings as your main residence for a period of up to six months provided:

· the old dwelling was your main residence for a continuous period of at least three months in the 12 months before you disposed of it,

· you did not use the old dwelling to produce assessable income in any part of that 12 months when it was not your main residence, and

· the new dwelling becomes your main residence.

When you construct a dwelling on vacant land that you own, you can choose to treat the land as your main residence for up to four years before the dwelling becomes your main residence. You can only make this choice if the dwelling you build on the land becomes your main residence as soon as practicable after construction is finished and continues to be your main residence for a minimum of three months. A consequence of making this choice is that for the period the choice applies, no other dwelling can be considered to be your main residence (except for the maximum six month period of time available under the moving from one main residence to another rule).

The absence rule allows you to chose to continue to treat a dwelling as your main residence for up to six years if the dwelling is rented after it ceases to be your main residence, provided you do not treat any other dwelling as your main residence for the period the choice is made.

Applying the main residence exemption and the home first used to produce income rule to property two

By examining relevant aspects of properties one, two and three, as well as your ownership and use of those properties and the choices you either have, or have stated you will make about the main residence exemption in relation to those properties, we can determine how the main residence exemption applies to property two. From that determination, we can establish whether or not you meet all the conditions required to apply the home first used to produce income rule to modify the cost base/reduced cost base of property two.

There has been an overlap of time in your ownership of properties one, two and three.

All properties are on less than two hectares of land.

Two of the properties (property one and property two) were acquired as vacant land. You built dwellings on these properties and occupied those dwellings as your main residence. There was an existing dwelling on property three (your current main residence) when you acquired it.

When you sold property one, you made a choice to apply the main residence exemption to property one for the whole of your ownership period of property one.

You have stated that you will chose to apply the main residence exemption to property three for the full period of time you own that property.

You used property two to produce income for a period of time after it ceased being your main residence. Accordingly, you will only be entitled to a partial main residence exemption for property two.

You meet the first two conditions required for the home first used to produce income rule to apply to your case because:

· you first used property two to produce assessable income at a later date, and

· only a partial main residence exemption is available to you in respect of property two because you used the property to produce assessable income.

The question then remains, do you meet the third condition required for the home first used to produce income rule to apply to your case? That is, would you have been entitled to a full main residence exemption for property two had you sold it immediately prior to first using it to produce income?

In your case, you were not entitled to a full main residence exemption for property two had you sold it immediately prior to first using it to produce income. This is the case because:

· Firstly, you chose to apply the main residence exemption to property one for your full period of ownership of that property. As a result, and with the exception of a six month period available to you under the moving from one main residence to another rule, you cannot apply the main residence exemption to property two during your overlapping period of ownership of properties one and two.

In this case, your overlapping ownership period of properties one and two was more than 6 months between zzzz and yyyy, only the last six of which can have the main residence exemption applied in respect of property two under the 'moving from one main residence to another' rule. Accordingly, you cannot apply the main residence exemption to the initial number of months of your ownership of property two.

In coming to the above conclusion, the application of the four year period potentially available to you to treat the vacant (at the time of acquisition) land at property two as your main residence under the constructing a dwelling on land you already own rule was also considered. However, with the exception of the six month period available under the moving from one main residence to another rule, you cannot choose to treat the vacant land at property two as a main residence because of your prior choice to apply the main residence exemption to property one for your full period of ownership of that property.

· Secondly, you have stated you will apply the main residence exemption to property three for the full period of time you own that property. Accordingly, you cannot choose the main residence exemption to apply to property two from the time you ceased to occupy property two onward and there is no extra six month period available to you (under the 'moving from one main residence to another' rule) after the time you moved from property two to property three because property two was not your main residence for any period of time in the last 12 months you owned property two.

· Lastly, because the absence rule can only be applied to a dwelling if you have no other main residence for the period a choice under the absence rule is made, you are unable to use the absence rule to apply the main residence exemption to any period after property two ceased being your main residence. This is because you have stated you will choose to apply the main residence exemption to property three for the full period you own property three.

In view of the above, there is only a period of approximately six years that the main residence exemption can apply to property two out of your total ownership period. This leaves a period in your ownership of property two where the main residence exemption cannot be applied. A portion of that period relates to the time before property two was first used to produce income.

Therefore, you do not meet the third condition required for the home first used to produce income rule to apply to your case. Accordingly, you cannot use a market valuation showing the valuation of property two at a later date as the cost base/reduced cost base of property two. Instead, you will need to reconstruct the cost of constructing the dwelling on property two in order to include that cost in your cost base/reduced cost base for property two.

Using estimates of construction costs for cost base purposes

The Australian Tax Office (ATO) view on the use of estimates of construction costs when actual construction expenditure is not available is contained in Taxation Ruling TR 97/25 Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements.

The view expressed in Taxation Ruling TR 97/25 is that the ATO will accept estimates of building costs if they are obtained from people who are likely to be accepted by a court or tribunal as an expert witness on the issue of calculating the cost of construction of a building with appropriate qualifications and expertise

Paragraph 28 of TR 97/25 specifies that people with the appropriate qualifications and expertise may include:

· a quantity surveyor with expertise in the relevant type of construction, or

· a builder who is experienced in estimating construction costs of similar building projects.

In your case, you have not retained records relating to the cost of construction of the dwelling on property two and you have stated it is not possible for you to obtain those records because of the period of time that has lapsed and because you were an owner builder.

You have requested that in the absence of original records for the cost of constructing the dwelling on property two, you be allowed to use a bank valuation to establish the cost base/reduced cost base for property two. You cannot do this because a bank valuation is not representative of the actual cost of constructing a dwelling. It is simply a value of the land and improvements to the land at a particular time.

To include the cost of constructing the dwelling on property two in your cost base/reduced cost base for property two, you must obtain an estimate of the cost of constructing the dwelling from an appropriately qualified person.

As you were an owner builder, the construction costs would only include the cost of materials and any payments you made to contractors.

Any costs you might calculate as being related to your own time spent working on the project cannot be included in the cost base/reduced cost base. This is because, as an owner builder, you are simply putting time into a project and no labour costs are incurred for that time. In contrast, when you engage a builder you incur costs for materials and labour, both of which can be included in the cost base.

Conclusion

You cannot use a bank valuation for property two to determine the cost base/reduced cost base of property two.

To include the cost of constructing the dwelling in the cost base/reduced cost base of property two, you will need to engage an appropriately qualified person to reconstruct the cost of constructing the dwelling.

The cost of constructing the dwelling is included under the fourth element of the cost base/reduced cost base of property two.

You cannot include any costs that you might calculate as being related to your own time spent working on constructing the dwelling in the cost base/reduced cost base for property two.

You are entitled to a partial main residence exemption for property two.

Your assessable income will include your share of the assessable gain made on the disposal of property two.

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