Edited version of your private ruling

Authorisation Number: 1012602338056

Ruling

Subject: Capital gains tax

Question 1

Is the cost base of your property the market value at the date it was first made available for rent?

Answer

Yes.

Question 2

Does the cost base of your property include acquisition costs, incidental costs of acquisition and disposal.

Question 3

Are you entitled to include a deduction for the decline in value of the air conditioner in the cost base of the property when the period of review for the relevant financial year has not expired?

Answer

No.

Question 4

Are you required to do a balancing adjustment in relation to items that have not been fully depreciated upon disposal of your property?

Answer

Yes

This ruling applies for the following period

Year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts and circumstances

You purchased the property after 20 September 1985.

You had a brief working holiday overseas when your sibling rented the unit from you.

The property continued to be your main residence during this period.

The property continued to be your primary place of residence until you moved out permanently.

From then until the sale in the 20XX financial year it was an investment property.

During the 20YY financial year the property was underpinned and updated. During this work the unit remained tenanted.

You have previously applied for a private ruling seeking clarification on what works could be claimed as deductions.

You were advised that the underpinning work would form part of the cost base and the air conditioner that needed replacing during the 20YY financial year was to be depreciated.

The unit was sold in the 20XX financial year for more than you originally paid for it.

Your arguments and references

You understand the cost base would be the value of the unit when it was rented out when you moved out permanently (not the original purchase price) plus the underpinning work.

This would come off the sale price. You could then use the discount method and the resulting amount will be applied to your taxable income (which would also include rental income up to the sale date) for the 20XX financial year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 20-30

Income Tax Assessment Act 1997 Section 49-295

Income Tax Assessment Act 1997 Section 100-45

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-235

Income Tax Assessment Act 1997 Section 110-5

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 112-50

Income Tax Assessment Act 1997 Subsection 118-190(b)

Income Tax Assessment Act 1997 Section 118-192

Reasons for decision

All references are to the Income Tax Assessment Act 1997.

Capital gains tax

Capital gains tax (CGT) is income tax paid on any net capital gain made as the result of a CGT event taking place. CGT events are the different types of transactions that may result in a capital gain or capital loss. As a general rule whenever you sell a CGT asset, such as property, that you acquired after 20 September 1985 (post-CGT) as part of a CGT event, you will be subject to the CGT provisions and you will need to determine whether a capital gain or capital loss has resulted. This is the most common CGT event and is known as CGT event A1. This occurred when you sold your unit.

As you are aware, a capital gain is added to any other assessable income you earned during the same year and you are then taxed at the appropriate marginal tax rate. A capital loss can be offset against other current year capital gains or carried forward indefinitely to be offset against future year capital gains.

Division 118 sets out various exemptions for many capital gains and losses and includes a full exemption if the asset you dispose of is your main residence for the entire time you owned it.

Subsection 118-190(b) explains that you only get a partial exemption if your main residence has been used for the purpose of producing assessable income during your ownership period.

Because your unit has produced assessable income for you, subsection 118-190(b) applies and you are entitled to a partial main residence exemption. The calculation of this partial exemption is explained later.

Cost base

Section 110-25 advises that the cost base of a CGT asset is made up five elements. The elements include the amount you paid to purchase the asset, plus most other incidental costs incurred along the way to maintain, keep or dispose of the asset.

Section 110-5 explains that you need to know if there are any modifications to the general rules about cost base and refers us to Division 112. Section 112-50 explains that when a dwelling that is your main residence begins to be used for the first time for the purpose of producing assessable income the total cost base is affected. This section then refers us to section 118-192 which outlines the special rule for first use to produce income.

Section 118-192 applies if:

• only a partial main residence exemption would be available under Subdivision 118-B because the dwelling was used for the purpose of producing assessable income during your ownership period; and

• the income producing use started after 7.30 pm (by legal time in the ACT) on 20 August 1996; and

• you would have been entitled to a full main residence exemption if you had entered into a contract to dispose of the dwelling just before the first time it was used for the income producing purpose.

As you satisfy all these conditions, you are taken to have acquired the unit for its market value at the time you first started using it for income producing purposes when you went overseas and your sibling rented the unit from you. Therefore the first element of the unit's cost base will be its market value on the day your sibling first rented it.

All the five elements that make up your total cost base are explained further below:

1. Acquisition costs, or in your circumstances, the first element is modified to be the market value of the unit at the date your sibling first rented the unit from you.

2. Incidental costs of acquiring the asset, or costs in relation to the CGT event. These costs include stamp duty, legal fees, agent's commission and fees paid for professional services.

3. Non-capital costs incurred in connection with ownership, for example, interest, rates, land tax, repairs and insurance premiums. Note however that these expenses cannot be included in the cost base if you were entitled to claim an immediate deduction for them each year. This would be applicable in the case of a rental property as these expenses are deductible each year.

They also include non-deductible interest on loans used to finance capital expenditure incurred to increase an asset's value.

4. Capital expenditure incurred to increase the value of the asset, if the expenditure is reflected in the state or nature of the asset at the time of the CGT event, for example, extensive renovations undertaken to the CGT asset.

This is where the cost of the underpinning will be included.

5. Capital expenditure incurred to preserve or defend the title or rights to the asset.

Please note, as mentioned above, you cannot include an expense in the cost base of the unit if:

• it is allowable as a deduction; or

• there is a non-assessable recoupment in respect of the expense. An assessable recoupment is defined as an amount received as recoupment of a loss or outgoing that was deducted, or can be deducted, under certain prescribed provisions in the tax law (which are listed in section 20-30). The insurance recoupment you received for replacement of the air conditioner is a non-assessable recoupment and cannot be included in the cost base.

The Commissioner issued Taxation Determination TD 2005/47 what do the words 'can deduct' mean in the context of those provisions in Division 110 of the Income Tax Assessment Act 1997 which reduce the cost base or reduced cost base of a CGT asset by amounts you 'have deducted or can deduct', and is there a fixed point in time when this must be determined?

You purchased a new air conditioner for the unit of which you recouped an amount from insurance. You were advised to depreciate this item over its effective life. You did not include a deduction for the decline in value for the air conditioner in your tax return for the year ended 30 June 20YY and as the period of review has not expired, you may still amend your tax return to include this deduction.

Deduction for depreciating assets

The deduction for the decline in value of a depreciating asset is calculated by spreading the cost of the asset over its effective life and using either the prime cost or the diminishing value method to determine the amount to be deducted each year.

The effective life of an asset is either self-assessed or determined by the Commissioner using the ATO Rulings published annually. (Taxation Ruling TR 2012/2 - Income tax: effective life of depreciating assets (applicable from 1 July 2012 states that the effective life of a split system air conditioner is 10 years.) The choice must be made for the year in which the asset is first used, or installed ready for use. There is a calculator available on the ATO website to assist in this calculation. The information required is:

• Description of the asset.

• Date started to decline in value (when installed ready for use).

• Acquisition date.

• Cost (less any recoupment from insurance).

• Non-taxable use percentage.

• Depreciation method.

• Effective life.

Balancing adjustment events

When a depreciating asset is sold, a balancing adjustment event happens for the asset (section 49-295). You must compare the asset's termination value with its adjustable value at that time. If the two figures are different, the difference is the balancing adjustment amount.

Generally, the termination value is the amount you receive for the asset on its disposal. It also includes the market value of any non-cash benefits such as goods or services you receive for the asset.

A depreciating asset's adjustable value at a particular time is generally its cost less its decline in value up to that time. Thus the adjustable value of the air conditioner will be the amount you were out of pocket less the calculated amount of decline in value deduction for the 20YY financial year.

The balancing adjustment amount is applied as follows:

• If the termination value of a depreciating asset is more than its adjustable value, the difference is included in your assessable income.

• If the termination value is less than its adjustable value, the difference is an allowable deduction.

The balancing adjustment amount is applied in the year the balancing adjustment event occurs (the year the unit was sold).

CGT event K7 (balancing adjustments for depreciating assets) also arises at the time of the balancing adjustment event if the asset was used wholly or partly for a non-taxable purpose.

As the new air conditioner was used wholly for a taxable purpose, CGT event K7 does not apply.

Taxation Determination TD 98/24 what are the CGT consequences of a CGT event happening to post-CGT real property if the property comprises separate CGT assets under Subdivision 108-D in Part 3-1 of the Income Tax Assessment Act 1997 (the 1997 Act) or if the property is sold with depreciable assets? explains that where a separate value of the air conditioner (or the depreciable asset) has been allocated by you and the purchaser of the unit, the Commissioner will normally accept that value.

However, in the absence of an agreed allocation, the Commissioner will accept a later agreement by the parties allocating the capital proceeds to the assets included in the sale (TD 98/24).

Example:

A replacement air conditioner cost $1,500 and has an adjustable value of $450 (after reducing the cost by the $1,000 recouped insurance and the first year's deduction for decline in value of $50). If the agreed value of the air conditioner on sale of the property is $950, an assessable balancing adjustment of $500 needs to be included at label 24 'Other income' in the tax return for the year in which the property was sold.

Alternatively, if the agreed value of the air conditioner on sale of the property is $400, then a balancing adjustment deduction of $50 is allowable under 'Other deductions' at label D15.

Calculating your capital gain

The steps to follow in calculating your capital gain are:

1. Determine the capital proceeds from the CGT event (the amount received from the sale).

2. Determine the cost base for the CGT asset (as discussed above, the market value when first used to produce income, plus all other incidental expenses included in the five elements).

3. Subtract the cost base from the capital proceeds.

4. The difference is your total capital gain.

This is the amount to be used in calculating your partial main residence exemption using the formula:

Capital gain or capital loss amount

multiplied by non-main residence days

divided by total days.

Non-main residence days are the number of days in your ownership period when the dwelling was not your main residence. This would be from when you moved out permanently and it became a rental property.

Total days are the amount days of your total ownership of the property.

In the usual kind of case where you acquire a dwelling under a contract and dispose of the dwelling under a contract, your ownership period of the dwelling will run from the time of the completion of the purchase contract (settlement) and end when the sale contract is completed (settlement). This is because the relevant dates for the main residence exemption are the settlement dates or, if you had a right under the purchase contract to occupy the dwelling at an earlier time, that time until settlement of the sale contract.

You then calculate your net capital gain as follows:

1. Reduce the capital gains for the income year by any capital losses for the income year. If the capital losses exceed the capital gains, the difference is your net capital loss. A net capital loss is not deductible from your assessable income but it can be carried forward for offset against capital gains in later years.

2. Reduce any remaining capital gains by any unapplied net capital losses for previous income years.

3. Reduce any remaining capital gains by the discount percentage which is 50%.

The resulting figure is your net capital gain to be included at label 18 of the supplementary income section of your tax return.

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