Edited version of your written advice

Authorisation Number: 1012784552172

Ruling

Subject: Property development

Question

Would the gain/profit from the sale of your redeveloped property be considered to be only a capital gain and not a profit on an isolated transaction which is taxed as ordinary income?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

The scheme commenced on:

1 July 2014

Relevant facts and circumstances

You purchased your home several years ago and have always used it as your main residence over that period.

You purchased the adjoining house a few years ago and have always used this property for investment purposes.

Both properties are on the same block of land under strata title.

You plan to demolish both your main residence and the investment property with the intention of building a number of dwellings over the two titles.

You are considering subdividing the land in order to do this but have not decided yet if that is the best course of action for you.

You will be using a building company and a real estate agency to manage the development and the sale of the new dwellings.

You will not be retaining any of the new dwellings as your main residence, you will instead utilise the proceeds from the sale of all properties to purchase a new home elsewhere.

You are not employed in the property development or real estate field.

You have no previous experience or expertise in subdivisions and developments.

You have no intention of repeating this activity once it is concluded.

You are undertaking this development and sale with the intention of getting the most out of your property in order to maximise the value you can take to your future home.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Reasons for decision

We need to determine whether the gain/profit from the sale of the land:

• is assessable ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as you were carrying on a business of property development

• is assessable ordinary income under section 6-5 of the ITAA 1997 as you conducted an isolated commercial transaction with a view to a profit, or

• is from a mere realisation of a capital asset and only assessable under the capital gains tax provisions of the ITAA 1997.

Carrying on a business of property development

Based on the information provided, we do not consider that any proceeds you would receive from the sale of the property would be derived in the course of carrying on a business.

Profits from an isolated transaction

Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium). 

Taxation Ruling TR 92/3 considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayer's business but:

• the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and

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

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case.  Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of land can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered:

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

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.

Miscellaneous Taxation Ruling MT 2006/1 provides a list of specific factors relevant to isolated transactions and sales of real property. If several of the factors are present, it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows:

• there is a change of purpose for which the land is held;

• additional land is acquired to be added to the original parcel of land;

• the parcel of land is brought into account as a business asset;

• there is a coherent plan for the subdivision of the land;

• there is a business organisation - for example a manager, office and letterhead;

• borrowed funds financed the acquisition or subdivision;

• interest on money borrowed to defray subdivisional costs was claimed as a business expense;

• there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

• buildings have been erected on the land

In determining whether activities relating to isolated transactions are an enterprise or are the mere realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above; however there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

MT 2006/1 provides the following example which is relevant to your case:

Example 31

284. Prakash and Indira have lived in the same house on a large block of land for a number of years. They decide that they would like to move from the area and develop a plan to maximise the sale proceeds from their land.

285. They consider their best course of action is to demolish their house, subdivide their land into two blocks and to build a new house on each block.

286. Prakash and Indira lodge the necessary development application with the local council and receive approval for their plan. They arrange for:

• their house to be demolished;

• the land to be subdivided;

• a builder to be engaged;

• two houses to be built;

• water meters, telephone and electricity to be supplied to the new houses; and

• a real estate agent to market and sell the houses.

287. Prakash and Indira carry out their plan and make a profit. They are entitled to an ABN in respect of the subdivision on the basis that their activities go beyond the minimal activities needed to sell the subdivided land. The activities are an enterprise as a number of activities have been undertaken which involved the demolition of their house, subdivision of the land and the building of new houses.

Application to your circumstances

In this case, when your original property was acquired several years ago, it was used as a private residence. You then purchased the adjoining dwelling and land title on your strata block for investment purposes a few years ago. We consider there would be a change of purpose for which the property is held when a decision is made to demolish the existing dwellings and build separate dwellings which you then intend to sell through a third party at arm's length.

You will be demolishing your main residence and the adjacent dwelling, then contracting a building company and a real estate agency to manage the development and the sale of the new dwellings. You are considering subdivision of the land as another option when you construct the new dwellings on that land, none of which will be your main residence.

We consider that you would be going above and beyond what would be required to realise the value of the land. Instead, it would appear that the project would have the characteristics of a commercial transaction.

Therefore, as you will be carrying out an isolated commercial transaction with a view to a profit, the profit made will be considered ordinary assessable income under section 6-5 of the ITAA 1997.

Further information

The inclusion of the gain/profit on the sale of the property as ordinary income does not mean that a capital gains tax (CGT) event does not happen in relation to the property. However, section 118-20 of the ITAA 1997 exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. In the absence of such a provision, it is conceivable that a receipt properly characterised as ordinary income and which has also been derived as a result of a CGT event could result in the receipt being taxed twice. Therefore, whilst a CGT event will occur when the property is sold (CGT event A1), any capital gain will be disregarded to the extent of any amount already included as ordinary assessable income under section 6-5 of the ITAA 1997.

CGT event C1 will also happen when the dwellings are demolished. However, a capital gain or loss does not arise at this time as you will not receive any capital proceeds from the demolition (ATO Interpretative Decision 2002/633).

In calculating the profit from an isolated transaction involving the one-off development of land, where the land has been held for some time (for private or other purposes) before entering into the profit making transaction, the sale proceeds will be reduced by the market value of the property at the time it was ventured into the commercial transaction (that is, at the time the property ceased its previous use and instead started being held for development) and costs associated with the development.

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