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Ruling

Subject: CGT- Disposal of property

Question:

Will you be required to pay capital gains tax on the sale of a property you acquired title to by adverse possession?

Answer:

Yes, if you dispose of the property, you will be required to pay capital gains tax on it. You are entitled to use either the indexation or discount method to ascertain the capital gain you are required to pay.

This ruling applies for the following period

1 July 2011 to 30 June 2012

The scheme commenced on

1 July 2011.

Relevant facts and circumstances

You purchased a property several years ago. The owner had been paying the rates and taxes on another property and passed that on to you as part of the deal.

You have paid the rates and taxes on this other property since that time.

You acquired a proper title to this other property through the law of adverse possession.

The property has mostly been used to provide firewood for personal use.

You stay at the property occasionally. You have built a shack, a road and a dam on the property.

Relevant legislative provisions

Land Titles Act 1980 (TAS) Part IXB

Limitation Act 1974 (TAS) Subsection 10(2)

Income Tax Assessment Act 1997 Division 109

Income Tax Assessment Act 1997 subsection 109-5(1)

Reasons for decision

Issue

You started paying the taxes and land rates on a property before 1985, however, you did not gain title to that property until several years ago. You want to know whether you are required to pay capital gains tax on this property, if you sell it.

Law

Capital gains tax (CGT) is the tax you pay on certain gains you make after 20 September 1985. You make a capital gain or capital loss as a result of a CGT event. The most common event is CGT event A1. CGT event A1 happens when you dispose of an asset to someone else. You are deemed to have disposed of an asset if a change in ownership occurs from you to another entity.

Generally, you acquire a CGT asset when you become its owner: Subsection 109-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997). If you obtain an asset without entering into a contract, the time of acquisition is when you start being the asset's owner.

Ownership interest:

In the case of land, you have an ownership interest if you have a:

· legal or equity interest in it, or

· right to occupy it.

The law recognises that title to property can be acquired based on a claim of adverse possession. In order for title to property to be adversely possessed, the person claiming title must establish that the time limit on the right of the registered proprietor to recover possession of the land has expired and that they satisfy the common law requirements of adverse possession.

In State X a person who has been dispossessed of their land cannot bring an action to recover their land after 12 years. A person that has been in possession of land owned by another person may acquire title to that land under the relevant act

In Taxation Determination TD 2004/731 the ATO formed the view that the taxpayer became the owner of the property when they satisfied the common law requirements to establish possessory title and the relevant limitation period expired. Therefore for the purposes of subsection 109-5(1) the taxpayer will be considered to be the owner of property when they satisfy all legislative and common law requirements necessary for title to pass under adverse possession laws, even if you have not made an official application.

Cost base:

The cost base of an asset is generally the cost of the asset when you bought it. It also includes certain other costs associated with acquiring, holding and disposing of the asset.

Elements of the cost base

money or property given for the asset

incidental costs of acquiring the CGT asset or that relate to the CGT event

costs of owing the asset

capital costs to increase or preserve the value of your asset or to install or move it

capital costs of preserving or defending your ownership of or rights to your asset.

If you did not incur expenditure to acquire the asset you substitute the market value of the property at the time of acquisition for the first element of the cost base.

Calculating your capital gain:

In some cases you may be able to choose either the discount method or the indexation method to calculate your capital gain. In these cases, you use the method that gives you the best result.

Indexation method:

You can use this method if:

· a CGT event happened to an asset you acquired before 11.45am on 21 September 1999, and

· you owned the asset for 12 months or more.

You must choose to apply this method. Under this method you increase each amount included in the cost base by an indexation factor.

Discount method:

Use the discount method to calculate your capital gain if:

· you are an individual, a trust or a complying superannuation entity

· a CGT event happens to an asset you own

· the CGT event happened after 11.45am on 21 September 1999

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

· you did not choose to use the indexation method.

If you use this method your capital gain will be reduced by the CGT discount.

Application of law to facts

As you acquired the property after 20 September 1985 you will be required to pay capital gains tax when you dispose of it. The main issue that needs to be addressed is when you are taken to have acquired the asset for taxation purposes.

It is important to ascertain when you acquired the CGT asset as this will determine whether or not you will be entitled to use the indexation method or the discount method to determine the capital gain you will be assessed on.

You stated that you did not apply for proper title before several years ago as you did not have the money or time to apply for it earlier, however, if you had the time and money you would have been able to obtain proper title before this date. According to Taxation Determination ATO ID 2004/731 you will be taken to have acquired the property you gained legal title. As your State's limitation period is 12 years, if you had satisfied the common law requirements of adverse possession, you would have been able to apply for proper title any time from when you were able to acquire title. Therefore you are able to use either the indexation method or discount method to work out you capital gain.

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