Edited version of your written advice

Authorisation Number: 1012724103886

Ruling

Subject: CGT - subdivision of property

Questions and answers

1. Is the subdividing of a block of land into two lots assessable as ordinary income?

No.

2. At the time the block of land is subdivided into two lots, are they subject to capital gains tax?

No.

3. When you sell the newly created lots of land will the sale of the lots be subject to capital gains tax?

Yes.

4. Does the cost associated with voluntary demolishing the rental property on the land being subdivided, form part of element four of the cost base?

Yes.

5. Does the costs of rates, taxes and interest incurred during the subdividing of the land and up to the sale date of the land, form part of element three of the cost base?

Yes.

6. Are the cost apportioned equally between the subdivided lots?

No.

7. Are you eligible for the 50% CGT discount on any capital gain made on disposal of the lots of land?

Yes.

This ruling applies for the following period(s)

1 July 2014 to 30 June 2015

1 July 2015 to 30 June 2016

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Post capital gains tax, 20 September 1985, you and your spouse purchased a property, with a land size approximately X square metres.

From the time of purchase the property was utilised as a rental.

After renting the property out for some considerable time, you experienced significant problems with the maintenance and tenanting of the property.

Due to anticipated extensive cost of future repairs to the property and that the house is located in the middle of the block, you have decided to demolish the house, subdivide the land into two lots and then sell the lots.

The only work you will be undertaking in the development of the property is to obtain the relevant approvals for the subdivision and organise the demolishing of the existing house.

A real estate agent will be engaged to sell the two lots of land.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 15-15

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 110-25

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

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

Income Tax Assessment Act 1997 Section 110-35

Income Tax Assessment Act 1997 Section 112-25

Income Tax Assessment Act 1997 subsection 112-25(2)

Income Tax Assessment Act 1997 Section 115-10

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not considered the application of Part IVA to the arrangement you asked us to rule on.

Reasons for decision

Ordinary Income

Under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), your assessable income includes the ordinary income you derived directly or indirectly from all sources, during the income year.

Additionally, section 15-15 of the ITAA 1997 includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan. However, this provision does not apply to a profit that is assessable as ordinary income under section 6-5 of the ITAA 1997, or which arises in respect of the sale of property acquired on or after 20 September 1985.

Although the legislation does not define income according to ordinary concepts, a substantial body of case law has evolved to identify various factors that indicate the nature of ordinary income.

In FC of T v The Myer Emporium (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 (Myer Emporium), the Full High Court expressed the view that profits made by a taxpayer who enters into an isolated transaction with a profit making purpose can be assessable income.

Taxation Ruling TR 92/3 considers the assessability of profits on isolated transactions in light of the principles outlined in Myer Emporium. According to Paragraph 1 of TR 92/3, the term isolated transactions refers to:

• those transactions outside the ordinary course of business of a taxpayer carrying on a business, and

• those transactions entered into by non business taxpayers.

Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction will generally be income when both the following elements are present:

• your intention or purpose in entering into the transaction was to make a profit or gain, and

• the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

Additionally, if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to commit the asset, either:

• as the capital of a business or

• into a profit-making undertaking with the characteristics of a business operation or commercial transaction, this activity constitutes the carrying on of a business, or a business operation or commercial transaction. The profit from such activity is income even though the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

Some of the factors to consider when looking at whether an isolated transaction amounts to a business operation or commercial transaction are listed at paragraph 13 of TR 92/3. They are: 

(a) the nature of the entity undertaking the operation or transaction

(b) the nature and scale of other activities undertaken by the taxpayer

(c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained

(d) the nature, scale and complexity of the operation or transaction

(e) the manner in which the operation or transaction was entered into or carried out

(f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction

(g) if the transaction involves the acquisition and disposal of property, the nature of that property and

(h) the timing of the transaction or the various steps in the transaction.

Profits on the sale of subdivided land can therefore be income according to ordinary concepts within section 6-5 of the ITAA 1997, or as a profit making undertaking or plan within section 15-15 of the ITAA 1997, if the taxpayer's subdivisional activities have become a separate business operation or commercial transaction, or an isolated profit making venture.

In contrast, paragraph 36 of TR 92/3 notes that the courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

Application to your circumstances

The investment property you purchased post CGT has been used as a rental. You have never been in the business of land development and you will have minimal involvement in the subdivision of the land.

Therefore, the proceeds you receive from the development of your property are not ordinary income and not assessable under sections 6-5 or 15-15 of the ITAA 1997. The proceeds represent a mere realisation of a capital asset which will fall for consideration under the CGT provisions in Part 3-1 and 3-3 of the ITAA 1997.

Capital Gains Tax

A capital gain or a capital loss may arise if a capital gains tax event (CGT event) happens to a capital gain tax asset (CGT asset). Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property, or a legal or equitable right that is not property.

Section 104-10(1) of the ITAA 1997 provides that a CGT event A1 happens if you dispose of a CGT asset. Section 104-10(2) provides that you dispose of a CGT asset if a change in ownership occurs from you to another entity, whether because of some act or event or by operation of law.

However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

Under subsection 112-25 of the ITAA 1997, subdividing land does not result in a CGT event. As such, you are not making a capital gain or capital loss at the time of the subdivision, you make the capital gain or loss at the time you enter into the contract for the disposal of the subdivided land or when the change in ownership occurs.

Section 112-25(2) of the ITAA 1997 provides that each element of the cost base and reduced cost base of the original asset is apportioned in a reasonable way and included in the corresponding element of the cost base and reduced cost base of each new asset.

Under section 110-25 of the ITAA 1997 there are five elements of the cost base they are;

1. The money paid or property given for the asset.

2. Incidental costs of acquiring the asset, or that relate to the CGT event that happens to the asset.

3. Certain non-capital costs of ownership.

4. Capital costs to increase or preserve the value of your asset or to install or move it.

5. Capital costs of preserving or defending your ownership of or rights to your asset.

Section 110-35 of the ITAA 1997 details the incidental costs of the second element which includes;

1) remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser.

2) costs of transfer

3) stamp duty or other similar duty

4) if you;

a. acquired a CGT asset - costs of advertising or marketing to find a seller, or

b. if a CGT event happened - costs of advertising or marketing to find a buyer

5) costs relating to the making of any valuation or apportionment for the purposes of this part

6) search fees relating to a CGT asset

7) cost of a conveyancing kit (or a similar cost)

8) borrowing expenses (such as loan application fees and mortgage discharge fees)

9) termination or other similar fees incurred as a direct result of your ownership of a CGT asset ending.

You do not include costs if you:

• have claimed a tax deduction for them in any year, or

• omitted to claim a deduction but can still claim it because the period for amending the relevant income tax assessment has not expired.

Subsection 110-25(4) of the ITAA 1997 provides 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). These costs include:

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

b) costs 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.

You do not include costs if you:

• have claimed a tax deduction for them in any year, or

• omitted to claim a deduction but can still claim it because the period for amending the relevant income tax assessment has not expired.

Subsection 110-25(5) of the ITAA 1997 provides that the fourth element is the capital costs you incurred for the purpose, or the expected effect, of increasing or preserving the assets value. These costs include:

a) costs incurred in applying (successfully or unsuccessfully) for zoning changes.

b) capital costs you incurred that relate to installing or moving an asset.

However, it does not include capital expenditure incurred in relation to goodwill, which may be deductible as a business-related cost.

Section 115-10 of the ITAA 1997 provides that a discount capital gain can be made by an individual. A 50% discount may be applied to a discount capital gain realised by an individual where;

• The asset that gave rise to the capital gain has been owned for a period of at least 12 months.

• Have disposed of the asset after 11:45am ACT legal time on 21 September 1999; and

• Did not choose to use the indexation method.

Application to your circumstances

As the subdividing of land does not result in a CGT event; when each of the lots are sold, a CGT event A1 will occur because you are disposing of a post CGT asset and a change in ownership will occur.

Under the fourth element of the cost base you may include the cost of the demolition, if the demolition expenses were incurred to enhance the value of the land and are reflected in the state or nature of the land at the time of a subsequent CGT event.

Under the third element of the cost base you may include, from the time the property was no longer a rental property to the sale date of each lot;

• Any interest expenses in relation to money you borrowed to acquire the asset.

• Interest on money you borrowed to refinance the money you borrowed to acquire the asset.

• Interest on money you borrowed to finance the capital expenditure you incurred to increase the asset's value.

You may also include in element three of the cost base rates and or land taxes you may have incurred from the time the property was no longer a rental property to the sale date of each lot.

The subdivision costs are apportioned between the blocks. If the blocks are of unequal market value the Commissioner considers that costs such as survey, legal fees and application fees associated with the subdivision should be apportioned in accordance with the relative market value of the blocks. However, any cost solely related to one block should be attributed to that block, for example the cost of connecting services.

You have held the asset for a period longer than 12 months; accordingly, you are entitled to apply the 50% discount to the capital gain made on the sale of each lot.

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).