Edited version of your written advice

Authorisation Number: 1012827806046

Date of advice: 25 June 2015

Ruling

Subject: Cost of renovations

Question 1

Is the income from the sale of the property assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes.

Question 2

Will the capital gains tax provisions apply in relation to the sale of the property?

Answer:

Yes.

Question 3

Will any capital gains be reduced by the amount assessable under section 6-5 of the ITAA 1997?

Answer:

Yes.

Question 4

Will the Commissioner accept the reconstructed records of the renovation costs for the purpose of calculating your assessable income?

Answer:

Yes.

This ruling applies for the following period

Year ending 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts

You purchased a property with the intention of renovating and selling it.

You performed extensive renovations to the property before selling the property 12 months after purchasing it.

You lost your principal place of residence in a fire which also destroyed all your records including your tax documents.

Whilst you have actual figures for the acquisition costs and sale proceeds you have reconstructed the renovation costs based on bank records and receipts.

You carried out most of the work yourself. A lot of the material was bought online. The reconstructed records show that the renovation costs were $XX,XXX.XX.

You are not in the business of property development.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 6-10.

Income Tax Assessment Act 1997 Division 121

Income Tax Assessment Act 1997 Subsection 121-20(5)

Reasons for decision

Assessable income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Under section 6-10 of the ITAA 1997, assessable income also includes statutory income.

Generally, if the sale of land constitutes a business or part of a business or a commercial transaction, then the proceeds will be assessable as ordinary income under section 6-5 of the ITAA 1997. On the other hand, if the sale is mere realisation of the land, the proceeds will be a capital amount. 

In certain circumstances profits from isolated transactions are considered to be ordinary income.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5 of the ITAA 1997.

The term isolated transaction refers to:

(a) those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

(b) those transactions entered into by non-business taxpayers.

We consider that your transaction is an isolated transaction as referred to in category (b) above.

If a taxpayer not carrying on a business makes a profit from an isolated transaction or operation, that profit is assessable income if both of the following elements are present:

1.     the intention or purposes of the taxpayer in entering into the transaction or operation was to make a profit or gain; and

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

Profit-making does not need to be the sole or dominant purpose for entering the transaction. A profit-making purpose must exist at the time the transaction or operation was entered into.

In your situation, you purchased property with the intention of renovating and then selling.

Although you are not in the business of property development, to decide if any profit you make is income, we need to consider if the transaction was entered into, and the profit was made in carrying out a business operation or commercial transaction.

For a transaction to be characterised as a business operation or commercial transaction, it is sufficient if the transaction is business or commercial in nature.

TR 92/3 lists the following as some matters which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction.

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 and the various steps in the transaction.

In considering whether your transaction amounts to a business operation or commercial transaction, the following matters are relevant:

• You are individual non-business taxpayers who purchased an investment property.

• You carried out extensive renovations to the property.

• The property was then sold after the renovations were complete.

• The nature, scale and complexity of the operation is significant.

Although you are not in the business of property development, it is not considered that the transaction is a mere realisation of an asset. You are not merely selling a property you had been using as a rental property or your home. Rather you purchased the property with the intention of renovating it and then selling it at a profit.

After objective consideration of these matters, we have determined that the renovation and sale of the property has the characteristics of a commercial transaction. That is, your transaction goes beyond that of a mere realisation of a capital asset.

As confirmed by the Full Federal Court in August & Anor v FC of T [2013] FCAFC 85; 2013 ATC 20-406, the profit from sale of properties acquired with the principal intention of re-selling for profit was ordinary assessable income.

Therefore, the sale is assessable as profit from an isolated transaction and any profit made on the sale of the property forms part of your assessable income under section 6-5 of the ITAA 1997.

In situations where the sale of an asset is not a mere realisation, it is the net profit from the isolated transaction which will be assessable as ordinary income - see FC of T v. Whitford Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031.

The cost of the renovation is relevant in determining the net profit that will arise from the sale of your property.

Capital gains tax provisions

Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is made only if a capital gains tax (CGT) event happens.

Under section 104-10 of the ITAA 1997, CGT event A1, relating to the disposal of a CGT asset, will happen when you dispose of your interests in the property.

You will make a capital gain if the capital proceeds from the disposal are more than the cost base.

Section 118-20 of the ITAA 1997 contains anti-overlap provisions which operate to reduce any capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 of the ITAA 1997 as a result of the sale, for example, as ordinary income under section 6-5 of the ITAA 1997.

In your case, although you are entitled to the CGT 50% discount, your capital gain will be reduced to nil under section 118-20 of the ITAA 1997.

Records

Division 121 of the ITAA 1997 addresses record keeping requirements under the CGT provisions.

It requires that you must keep records of every act, transaction, event or circumstance that may be relevant to working out whether you have made a capital gain or capital loss from a CGT event.

If records are lost or have not been maintained for the purpose of calculating your CGT cost base you should first make an attempt to obtain the relevant documentation by approaching the relevant parties and obtaining copies. These may be obtained from builders, contractors, accountants, insurance bodies, solicitors, real estate agents and/or government authorities. 

In the event that the necessary documentation cannot be obtained, subsection 121-20(5) of the ITAA 1997 provides that if the necessary records of an act, transaction, event or circumstance do not already exist, you must reconstruct them or have someone else reconstruct them. 

Although the above legislation relates to CGT, the principles can be applied to calculating your net profit under section 6-5 of the ITAA 1997.

In your case, you incurred costs in renovating your property. You do not have all receipts and invoices relating to these costs and have reconstructed your records.

In your specific circumstances, the reconstructed costs of the renovations totalling $XX,XXX.XX will be accepted for the purpose of calculating your assessable income.

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