Edited version of your written advice

Authorisation Number: 1013080717061

Date of advice: 30 August 2016

Ruling

Subject: Capital gains tax - property - subdivision - income v capital

Question 1:

Will the profit from the sale of subdivided blocks of land be treated as ordinary income under section 6 -5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of you carrying on a business of property development?

Answer:

No.

Question 2:

Will the profit from sale of subdivided blocks of land be treated as ordinary income under section 6-5 of the ITAA 1997 as a result of an "isolated transaction" carried out for profit and commercial in character?

Answer:

No.

Question 3:

Will the profit from the sale of sale of subdivided blocks of land be treated as statutory income under the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997 as a mere realisation of your assets?

Answer:

Yes.

Question 4:

Will you be entitled to fully disregard the capital gain made on the disposal of the subdivided lots?

Answer:

No. However, you will be eligible to disregard any capital gain made on the disposal of your pre-capital gains tax ownership interests in the subdivided lots.

This ruling applies for the following periods

Income year ending 30 June 2016

Income year ending 30 June 2017

Income year ending 30 June 2018; and

Income year ending 30 June 2019.

The scheme commences on

1 July 2016.

Relevant facts and circumstances

You and your spouse purchased a property (Property 1) as joint tenants, with settlement occurring before 20 September 1985.

The land area of Property 1 is less than two hectares and was zoned residential at the time it was purchased.

You and your spouse built your home (the House) on Property 1 a number of years after it was purchased, in which you lived and raised your family.

You and your spouse purchased the property adjoining Property 1 (Property 2) as joint tenants a number of years after the completion of the construction of the House, prior to 20 September 1985, so that you could have a larger yard.

The land area of Property 2 is less than 2 hectares and was zoned residential at the time it was purchased.

Your spouse passed away after 20 September 1985.

You continued to reside in the House for a number of years after your spouse had passed away and had then moved into a nursing home where you continue to live until the present time.

The House has remained vacant since you moved out and has not been used to produce assessable income.

You want to demolish the House and subdivide each property into two subdivided lots, undertaking minimal infrastructure activities required to subdivide the properties, with no roads or building to be erected on either property.

The titles of the two properties have not been merged into one title and will remain on separate titles.

The market value of Property 1 prior to any subdivision activities is estimated at $XXX,000.

The market value of Property 2 prior to any subdivision activities is estimated at $XXX,000.

It is estimated that each of the subdivided lots could be sold for around $XXX,000 each.

It has been guesstimated that the costs for the subdivision activities will be around $XX,000 per lot.

You will use your personal savings to pay for the subdivision of the properties.

The services of real estate agents will be engaged to sell the subdivided lots.

With the assistance of your children, you will engage the services of other parties to undertake the activities in relation to the subdivision of the properties.

Neither you nor any related entities have undertaken any similar development activities in the past, and neither you nor any related entities have any intention to undertake similar activities in the future.

For the purposes of this ruling the following will occur:

• The House will be demolished;

• You will engage the services of others to undertake the activities in relation to the subdivision of Property 1 and 2;

• Property 1 and 2 will both be subdivided into two subdivided lots of vacant land;

• You will engage the services of real estate agent/s to sell the subdivided lots;

• You will not undertake any activities in relation to the subdivision of the properties and the sale of the subdivided lots; and

• The subdivision of Property 1 and 2 will be undertaken in accordance with a Development Permit/s, with no construction occurring on the subdivided lots prior to them being sold.

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 102-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Subsection 104-10(3)

Income Tax Assessment Act 1997 Section 112-25

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 Section 118-110

Income Tax Assessment Act 1997 Section 118-120

Income Tax Assessment Act 1997 Section 118-165

Income Tax Assessment Act 1997 Division 115

Reasons for decision

Legislative references referred to herein are from the ITAA 1997.

QUESTIONS 1, 2 AND 3

Summary

The proceeds from the sale of the subdivided lots of vacant land will not be ordinary income and will not assessable under section 6-5. Instead the proceeds represent a mere realisation of your capital assets to their best advantage which will fall for consideration under the capital gains tax provisions contained in Part 3-1.

Detailed Explanation

Income or capital

As a general principle, profits from property sales will either be assessable as ordinary income under section 6-5 or statutory income under capital gains tax provisions.

Where the profit has been made as a result of a taxpayer carrying on a business of property development or as a result of a taxpayer entering into an isolated business transaction, the profit will be assessable as ordinary income. However, where the profit is a mere realisation of a capital asset, the profit will be assessable under the capital gains tax provisions.

The term 'business' ordinarily refers to trade engaged in on a regular or continuous basis. To be engaged in a business of selling property, a taxpayer would need to be buying land and selling property on a regular basis.

Whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

Taxation Ruling 97/11 (TR 97/11) outlines the Commissioner's view on whether a taxpayer is carrying on a business. Ultimately, the question of whether the activities of a taxpayer amount to a business is decided on the facts of each case. The Commissioner and the courts consider that the following matters are relevant in determining whether a taxpayer is conducting a business of acquiring property for the purpose of making a profit on its subsequent sale:

1. whether the activity has a significant commercial purpose or character

2. whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

3. whether there is repetition and regularity of the activity

4. whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business

5. the volume of the operations and the amount of capital employed

6. whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit, and

7. the size, scale and permanency of the activity.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial profile.

The Commissioner's view on whether profits from isolated transactions are assessable as ordinary income is found in Taxation Ruling TR 92/3 (TR 92/3). 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 states that profits on an isolated transaction will be ordinary income when:

• the intention or purpose of a taxpayer 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 operation or commercial transaction.

A transaction that is commercial in nature will be a 'business or commercial transaction'.  Broadly, a commercial transaction is one that will constitute carrying on a business except that there are no recurring transactions.  Further, an isolated transaction refers to a transaction that is outside the ordinary course of business of a taxpayer carrying on a business and those transactions entered into by non-business taxpayers.

In general, whether a profit from an isolated transaction is income according to ordinary concepts depends very much on the individual circumstances of the case. Matters listed in TR 92/3, which are relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction include:

• the nature of the entity undertaking the operation or transaction

• the nature and scale of other activities undertaken by the taxpayer

• the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained

• the nature, scale and complexity of the operation or transaction

• the manner in which the operation or transaction was entered into or carried out

• the nature of any connection between the relevant taxpayer and any other party to the operation or transaction

• if the transaction involves the acquisition and disposal of property, the nature of that property; and

• the timing of the transaction or the various steps in the transaction.

Application to your situation

In this case, you and your spouse purchased Property 1 before 20 September 1985, and constructed a House on the property a number of years later which was your family home.

You and your spouse purchased the adjoining property, Property 2 a number of years later, prior to 20 September 1985, to provide you and your family with a larger yard.

Your spouse passed away after 20 September 1985, and you continued to reside in the House for a number of years after your spouse had passed away until you moved into a nursing home, where you continue to reside until the present time.

You want to demolish the House and subdivide both Property 1 and 2 into two lots, for the purpose of selling the subdivided lots of vacant land.

You will engage the services of others to undertake the activities in relation to the subdivision of the properties and the sale of the four subdivided lots.

You have not previously undertaken any similar activities and have no intention to undertake any similar activities in the future.

Based on the information provided, there is nothing to suggest that the subdivision of the properties and the sale of the subdivided lots of vacant land will be the beginning of a continuing business of property subdivision and sales. Your activities do not display the salient indicator of a business, being transactions entered into on a continuous and repetitive basis. Therefore, it is the Commissioner's view that your activities in relation to the subdivision of Property 1 and 2, and the sale of the subdivided lots are not those of someone carrying on a business of subdividing and selling land.

Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that the sale of the subdivided lots will not be considered commercial in nature, given that the properties have been long-held privately owned properties.

In conclusion, the activities involved in the subdivision of the properties and the sale of the subdivided lots of vacant land will not amount to carrying on a business. The transactions will not have the character of business operations or commercial transactions. There is no indication that your activities will become a separate business operation or commercial transaction, or that you will be carrying on, or are carrying out a profit-making undertaking or plan. Therefore, any gain made on the disposal of the subdivided lots will not be assessable as ordinary income under section 6-5.

Mere realisation

The capital gains tax provisions are contained in Part 3-1. Broadly, the provisions include in your assessable income any assessable gain or loss made when a capital gains tax event happens to a capital gains tax asset that you own.

Application to your situation

As outlined above, it is not viewed that you are carrying on a business, or that the subdivision activities will be an isolated transaction. Accordingly it is considered that the profit from the sale of the subdivided lots will not constitute ordinary income in terms of section 6-5.

Therefore, any profit arising from the sale of the four subdivided lots will be a mere realisation of the properties which will be accounted for under the capital gains tax provisions in Part 3-1 when the subdivided lots are disposed of.

QUESTION 4

Capital gains tax

Capital gains tax (CGT) is tax you pay when a CGT event happens to a CGT asset, such as land.  The most common CGT event is CGT event A1, which occurs when you dispose of your ownership interest in a CGT asset to another party, such as when you sell the land.

You will make a capital gain if the capital proceeds received for the asset are more than the asset's cost base. You will make a capital loss if the capital proceeds received for the asset are less than the asset's cost base.

Generally, you can disregard any capital gain or capital loss you make on an asset if you acquired it before 20 September 1985, being pre-CGT.

Main Residence Exemption and Land Adjacent to your Dwelling

Generally, you can ignore a capital gain or capital loss you make from a CGT event that happens to a dwelling that is your main residence.

The main residence exemption can include land adjacent to the dwelling to the extent that it is used primarily for private or domestic purposes in association with the dwelling.  

If you dispose of adjacent land to the same person at the same time as you dispose of your main residence, the exemption extends to the adjacent land. However, if you dispose of adjacent land at a different time than you dispose of your main residence, the exemption does not apply to the adjacent land.

Subdivision of Land 

If a taxpayer subdivides a block of land, each block that results is registered with a separate title. For CGT purposes, where the original land parcel is divided into two or more separate assets, the acquisition date of each of the subdivided lots will be the same as the acquisition date of the original asset.

Subdividing land does not result in a CGT event if the taxpayer retains ownership of the subdivided blocks. Therefore, the taxpayer does not make a capital gain or a capital loss at the time of the subdivision.

Application to your situation

In your case, you and your spouse each acquired a 50% pre-CGT ownership interest in Property 1 when it was purchased before 20 September 1985.

The House was constructed on Property 1 a number of years later, which was your family's home.

You and your spouse each acquired a 50% pre-CGT ownership interest in Property 2 when it was purchased a number of years later, prior to 20 September 1985.

When your spouse passed away after 20 September 1985, their ownership interests in the properties passed to you. As a result, you are viewed as having the following ownership interests for CGT purposes in the properties after your spouse passed away:

• 50% pre-CGT ownership interest in Property 1, acquired prior to 20 September 1985

• 50% post-CGT ownership interest in Property 1, acquired after 20 September 1985

• 50% pre-CGT ownership interest in Property 2, acquired prior to 20 September 1985; and

• 50% post-CGT ownership interest in Property 2, acquired after 20 September 1985.

You continued to reside in the House for a number of years, until you moved into a nursing home.

You intend demolishing the House and subdividing both Property 1 and 2 into two subdivided lots of vacant blocks of land, which you will sell.

When you subdivide the two properties, for CGT purposes you will be viewed as having a pre-CGT and post-CGT ownership interest in each of the subdivided lots.

A CGT event A1 will occur when each of the subdivided lots is sold and any gain made on the sale of the subdivided lots will need to be determined in the income year in which they are sold.

As the subdivided lots are not being sold with the House, the main residence and adjacent land exemptions will not be applicable. Therefore, the full gain made on the disposal of the subdivided lots cannot be disregarded.

Any capital gain made on the disposal of your post-CGT ownership interests in each of the four subdivided lots cannot be disregarded. The cost base of the land will need to be apportioned on a reasonable basis, such as an area basis or relative market value, when calculating the capital gain being made on the disposal of the subdivided lots.

As outlined above, you have a pre-CGT ownership interest each of the four subdivided lots. Accordingly, any capital gain made on the disposal of your pre-CGT ownership interests in each of the subdivided lots can be disregarded.

In conclusion, you will only be assessable on the capital gain made on the disposal of your post-CGT ownership interest in each of the subdivided lots. Any capital gain made on the disposal of your pre-CGT ownership interests in each of the subdivided lots can be disregarded.

Note: If you meet the conditions contained in Division 115, the 50% CGT discount can be applied to any gain made on the disposal of your post-CGT ownership interests in the four subdivided lots.

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