Edited version of your written advice

Authorisation Number: 1012711270798

Ruling

Subject: private residence in business property

Questions and Answers:

1. For the purpose of calculating the capital gain on the sale of your business, can you apply the main residence exemption to the room in your business property used for your private residence?

Yes.

2. Should expenditure you incurred for redrawing and certifying the property plans and expenditure paid to a real estate agent for the purpose of selling your business but who did not sell your business be included in your capital gains tax (CGT) cost base of your business asset sold (and thereby reducing your capital gain)?

Yes.

3. In general, are capital contributions made by a working partner included in their CGT cost base of your business asset sold (and thereby reducing their capital gain)?

No.

4. In general, can expenditures you have deducted against your ordinary business income in the past (such as interest expense, repairs, etc) be used to reduce your above capital gain?

No.

This ruling applies for the following period:

Year ended 30 June 2014

The scheme commences on:

1 July 2013

Relevant facts and circumstances

You purchased a business in partnership. In addition, you paid the vendor financier's legal and mortgage release fees. A few years later you also paid a legal payment to release the caveat the vendor had over funding.

At a later time, you sold your home to pay for extensive repairs to the business premises. In general, these repair costs were claimed as deductions against your business income in your income tax returns. These repairs including turning a room in the business into a one room flat to use as your private residence.

During this period, the one partner who worked externally as a tradesman often made contributions of capital to the business partnership, which were used to meet various commitments. There was no formal loan agreement for these contributions of capital.

In 2014, you sold the business, for which you incurred legal and mortgage release fees. At the time of sale, you also had to incur costs to redraw and certify the property plans for the sale to proceed.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 118-110

Income Tax Assessment Act 1997 Section 118-115

Income Tax Assessment Act 1997 Section 118-190

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 110-35

Income Tax Assessment Act 1997 Section 110-45

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 104-25

Reasons for decision

Main residence exemption

If you are an individual, in general, section 118-110 of the Income Tax Assessment Act 1997 (ITAA 1997) exempts a capital gain you make from a CGT event that happens in relation to a CGT asset that is a 'dwelling' or your ownership interest in it and the dwelling was your main residence.

However, under section 118-190 of the ITAA 1997, this exemption may not apply in full if it was your main residence during only part of your ownership period or it was used for the purpose of producing assessable income.

Section 118-115 of the ITAA 1997 includes in the meaning of a 'dwelling': a unit of accommodation that is a building or is contained in a building and consists wholly or mainly of residential accommodation.

Whether a structure is a dwelling for CGT purposes will depend on the facts of each case. In Campbell v. O'Sullivan [1947] SASR 195 at 201 it was held that:

…"Dwelling" ordinarily signifies a place of abode or residence, a tenement, habitation, or house, which premises a person or persons are using as a place for sleeping, and usually for the provision of some or all of their meals. The word is not used as a term of art, and has to be interpreted in accordance with its ordinary, proper, and grammatical sense in the context in which it appears...

The Tax Office publication Guide to capital gains tax 2014 simply states a dwelling is anything that is used wholly or mainly for residential accommodation.

Taxation Determination TD 1999/66 is about factors taken into account in determining the non-exempt amount under section 118-190 of the ITAA 1997. It provides, in most cases, it is appropriate to calculate the non-exempt amount on this basis of floor area, taking into account also the time that the area has been used for income producing purposes. It provides the following example:

John, a carpenter, has lived in his home for 10 years and he owns it. He has used the garage as a workshop for his carpentry business for the whole 10 years. Based on the area of the dwelling occupied by the garage, John estimates the workshop is 20% of the area of the whole dwelling. This is the basis on which John would have claimed an interest deduction if he had a mortgage on the property. John sells the home and makes a capital gain of $25,000 from that CGT event. Apart from section 118-190, as the dwelling was John's main residence he would have been able to disregard the whole capital gain of $25,000. However, applying subsection 118-190(2), John has a capital gain of $5000 (20% of $25, 000) to be included in his assessable income.

Taxation Ruling TR 93/30 is about home office expenses and some factors it uses to indicate whether an area set aside has the character of a "place of business" include: (i) the area is clearly identifiable as a place of business; (ii) the area is not readily suitable or adaptable for use for private or domestic purposes in association with the home generally; (iii) the area is used exclusively or almost exclusively for carrying on a business; and/or (iv) the area is used regularly for visits of clients or customers.

In your case, you can apply the main residence exemption to the rooms, veranda and garage in your business property used for your private residence, on the basis of floor area, taking into account also the time that the area had been used for private residence purposes.

However, you should also amend your relevant income tax returns to exclude the same portion of interest and other expenses you have claimed in relation to this private residence (since section 8-1 of the ITAA 1997 prohibits a deduction for losses and outgoings of a private or domestic nature).

Capital gains tax: cost base: incidental costs

Under subsections 110-25(3) and 110-35(1) of the ITAA 1997, the second element of the cost base of a CGT asset includes the incidental costs that you incur in acquiring the asset or which relate to a CGT event that happens in relation to the asset.

Incidental costs that can be included in the cost base of a CGT asset are set out in section 110-35 of the ITAA 1997 and include remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser.

However, subsection 110-45(1B) of the ITAA 1997 provides expenditure does not form part of the second element of the cost base to the extent that you have deducted or can deduct it.

In your case, you incurred various costs that were capital in nature and were/are expected to be included in your CGT cost base, such as (i) paying the vendor financier's legal and mortgage release fees; (ii) a legal payment to release the caveat the vendor had over funding; (iii) expenditure paid to redraw and certify the business property plans for the sale to proceed; and (iv) expenditure paid to a real estate agent for the (unsuccessful) purpose of selling your business.

It follows you can include the above mentioned costs in your CGT cost base of your business asset sold unless you have already deducted them. This prohibition under subsection 110-45(1B) of the ITAA 1997 includes if the relevant expenditure was of a capital nature and deducted as a business expense in error.

Capital contributions

Section 108-5 of the ITAA 1997 provides a debt owed to you is a CGT asset. Where a debt owed to you cannot be recouped, in general, a capital loss will happened under section 104-25 of the ITAA 1997 when the asset ends.

For example, a capital contribution made by a shareholder to their private company is deemed to be a 'loan' because the shareholder and the private company are two separate entities. If the company cannot repay the loan due its insolvency, a capital loss will happen to the shareholder under section 104-25 of the ITAA 1997 because the debt owed to the shareholder is irrecoverable.

However, in the case of a partnership, an individual partner is not a separate entity to the partnership. Taxation Ruling TR 94/8 (which is about when business is carried on in partnership, including 'husband and wife' partnerships) states, at paragraph 28, that:

…with a partnership, as partners are obliged, jointly and severally, to meet the partnership debts to the full extent of their own resources.

Importantly, unlike a company-shareholder relationship, in which a company cannot distribute its trading losses to its shareholder/s, a partnership can distribute its trading losses to its partners.

It follows, in general, a capital loss will not happen in relation to contributions made by a partner to a partnership because: (i) the individual partner is personally obliged, jointly and severally, to meet the partnership debts to the full extent of their own personal resources; and (ii) contributions made to the partnership are directly recouped in the form of profit or loss distributions made to the partner by the partnership.

For example, if a partner (employed externally) contributes $100 to the partnership and that $100 is spent to purchase stock and the stock cannot be sold and is written off, the partnership will make a loss of $100 and that $100 loss will be distributed to the partners. Here, the contributing partner will receive a $50 loss distribution, which is offset against their other assessable income. The non-contributing partner will also receive a $50 loss distribution, which they can offset against any assessable income. Therefore, the partners have already received a taxable loss for the capital contribution, which shows why a capital loss does not happen under section 104-25 of the ITAA 1997.

Anti-overlap provisions

As explained above, subsection 110-45(1B) of the ITAA 1997 provides expenditure does not form part of the second element of the cost base to the extent that you have deducted or can deduct it.

Similarly, section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent which they are incurred in gaining or producing assessable income but prohibits a deduction where the loss or outgoing is of a capital nature.

In your case, you cannot include in your CGT cost base expenditure that has been previous deducted. This includes if the relevant expenditure was of a capital nature and deducted in error.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).