Edited version of your written advice

Authorisation Number: 1012766640468

Ruling

Subject: Land subdivision - mere realisation - main residence exemption - gifting

Questions and Answers:

1. Will your sales proceeds from your subdivision of land ('Property') be capital proceeds under the capital gains tax (CGT) provisions?

Yes.

2. Since you demolished your residential house that was on your Property, will any of your subdivided lots sold qualify you for the main residence exemption?

No.

3. Will capital gains tax apply if you gift one lot to your children?

Yes.

This ruling applies for the following periods:

Year ending 30 June 2015

The scheme commences on:

1 July 2014

Relevant facts and circumstances

In 1996, you acquired your main residence.

In 2014, you have demolished the existing house and subdivided the land into blocks, retaining one block for yourselves as your main residence.

You employed various third parties to undertake the subdivision and sales of the land. Your related company will also be paid a percentage of the sale proceeds for acting as 'Project Manager' for the services of consulting with the council, assembling quotations and overseeing to completion of sales.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 115-25

Income Tax Assessment Act 1997 Section 116-30

Income Tax Assessment Act 1997 Section 118-110

Reasons for decision

Subdivision of land

Profits from a land sub-division can be treated in at least three ways for taxation purposes:

(1) As ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), as a result of carrying on a business of property development and the sale of land as trading stock.

(2) As ordinary income under section 6-5 of the ITAA 1997, as a result of an isolated commercial transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business.

(3) As capital gains under Part 3-1 and Part 3-3 of the ITAA 1997, from the mere realisation of a capital asset.

The term 'business' ordinarily refers to trade engaged in on a regular or continuous basis. Whereas an isolated (one-off) commercial transaction does not amount to a business but has the characteristics of a 'business deal'. Taxation Ruling TR 92/3 explains, for an isolated commercial transaction to occur, it is usually necessary the taxpayer has the purpose of profit-making at the time of acquiring the property and that the property has no use other than as the subject of trade.

The mere realisation of a capital asset was described in Commissioner of Taxes v Melbourne Trust Limited [1914] AC 1001 as "liquidating or realising the old assets".

In The Alabama Coal, Iron, Land and Colonization Co Ltd v Mylam (1926) 11 TC 232, a commercial transaction was distinguished from a mere realisation as "there must be something in the nature of buying at any rate, and not merely selling, which is mere turning your property into money''.

In the High Court of Australia case of Federal Commissioner of Taxation v NF Williams 72 ATC 4188; (1972) 127 CLR 226, Gibbs J explained mere realisation of land as follows:

An owner of land who holds it until the price of land has risen and then subdivides and sells it is not thereby engaging in an adventure in the nature of trade, or carrying out a profit-making scheme. The situation is not altered by the fact that the landowner seeks and acts upon the advice of an expert as to the best method of subdivision and sale or by the fact that he carries out work such as grading, levelling, road-building and the provision of reticulation for water and power to enable the land to be sold to its best advantage. The proceeds resulting from the mere realization of a capital asset are not income either in accordance with ordinary concepts…even though the realization is carried out in an enterprising way so as to secure the best price…

In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135, Ryan J described a salient characteristic of the mere realisation of land as follows:

…[to not] undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks....Had he constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement.

In your case, your sales proceeds from your subdivision of land are proceeds from the mere realisation of a CGT asset because: (i) your Property was not originally purchased for the purpose of subdivision; (ii) the land had another purpose other than the subject of trade, namely, long term residential; (iii) you merely realised or sold an old asset; (iv) you did not undertake any development of the land beyond what was necessary to secure the approval by the municipal authorities to enhance the presentation of individual allotments for sale as vacant blocks.; and (v) your personal involved in the development and sale of the land was not to any degree that would amount to carrying on a business.

Main residence exemption

Subdivision 118-B of the ITAA 1997 disregards a capital gain or capital loss that happens to a dwelling that is a main residence. A 'dwelling' includes a building that is a unit of accommodation and the land immediately underneath that building (section 118-115 of the ITAA 1997). Subsection 118-120(3) of the ITAA 1997 extends the area of adjacent land that is used primarily for private or domestic purposes (less the area of the land immediately under the dwelling) to a maximum of 2 hectares.

Taxation Determination TD 1999/73 explains land under a unit of accommodation qualifies for the main residence exemption only if the land and the unit of accommodation are sold together as a dwelling.

In your case, you do not qualify for the main residence exemption in relation to any vacant lots sold because to qualify for the exemption your residence house was required to be sold with the land.

Gifting to children

Section 116-30 of the ITAA 1997 provides if you received no capital proceeds from a CGT event (or if you received capital proceeds more or less than the market value of the asset) and you and the entity that acquired the asset from you did not deal with each other at arm's length in connection with the event, you are taken to have received the market value of the CGT asset that is the subject of the event. The market value is worked out as at the time of the event.

In your case, if you gift a lot to your children, the gifting of the land will result in a CGT event and will be subject to capital gains tax because of the market value substitution rule.

Additional information

In general, section 115-25 of the ITAA 1997 provides to be a discount capital gain, the capital gain must result from a CGT event happening to a CGT asset that was acquired by the entity making the capital gain at least 12 months before the CGT event. The discount percentage is 50%. In your case, both your sale and gifting of subdivided lots will qualify for discount capital gains.

Also, a taxpayer will qualify for a full main residence exemption for a dwelling that was built to replace a main residence that was demolished provided that: (i) the taxpayer makes a valid choice under section 118-150 of the ITAA 1997 to treat the land on which the new dwelling was constructed as their main residence from the time that the demolished dwelling was last occupied by the taxpayer; and (ii) the other requirements for a full main residence exemption in Subdivision 118-B of the ITAA 1997 are met. It does not matter whether the demolition of the first dwelling was voluntary or involuntary.

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