Edited version of private advice

Authorisation Number: 1051509829288

Date of advice: 20 May 2019

Ruling

Subject: Income and capital - demolition and rebuild of your apartment and building

Question 1

Will the demolition and rebuilding of your unit trigger a CGT event for you?

Answer

Yes

Question 2

If the unit is your main residence at the time of demolition would you be able to disregard any capital gain under Division 118 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes to the extent it was your main residence for the period of ownership. A partial main residence calculation may be applicable where you had another main residence during the period of ownership of this property.

Question 3

If the unit is your main residence at the time of completion of the rebuild (ie practical completion of the replacement apartment) would you be able to disregard any capital gain under Division 118 of the ITAA 1997?

Answer

No there is no capital gain or capital loss at that point in time (after the disposal when the property was demolished), until there is a disposal of the property.

Question 4

Will you be assessable on any net proceeds (or overall gain) from the disposal of the newly created apartments?

Answer

Yes, these net proceeds are assessable as ordinary income under section 6-5 of the ITAA 1997.

Question 5

If so, will these assessable amounts be a receipt on capital account?

Answer

No, as above the net proceeds are assessable as ordinary income under section 6-5 of the ITAA 1997.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

20 May 20XX

Relevant facts and circumstances

Background

The strata corporation owns the property that consists of a strata-titled low storey apartment building with apartments together with airspace rights above the building. The strata plan was deposited before 19 September 1985. You are a unit holder of a unit in the building. The strata corporation does not and has not earned any income from the common property.

The project

The corporation has identified an opportunity to redevelop the site to build a larger, better-designed and more valuable apartment building. The intended scope of the project is as follows:

a)    the existing apartment building on the site will be demolished

b)    a new taller apartment building will be rebuilt on the site

c)    a number of apartments of the redeveloped property will have the same essential specifications as is existing (ie bedroom and bathroom count) and will be given to the existing owners as replacements for their current apartments

d)    the ground floor of the redeveloped property will be used for car parking

e)    the replacement apartments will be positioned on the lower levels of the redeveloped property

f)     to fund the project, the remaining floors of the redeveloped property will be developed and sold as residential apartments.

It is anticipated that the finance would come from a banking institution or a capital building company that would profit share. Both providers will finance a project that is fully costed and all pre-sold (ie all new apartments pre-sold before demolition begins).

There is expected to be a profit from selling the new apartments.

The developer of the site will be the corporation, and it will contract a third party builder at commercial rates to build the redeveloped property. The corporation has never previously undertaken a project such as this and is not in the business of developing or redeveloping property. They expect that this will be the only property development project that it will undertake.

Your apartment

You acquired an apartment after 19 September 1985 with a view to:

a)    rent it out as an investment property in the short to medium term and

b)    in the longer term, potentially living in the property in your retirement years.

Since you acquired the property you have rented it out as an investment property on arm's length terms. You own one other investment property in the same suburb which is rented under the same terms.

The attributes of your current apartment are:

·         a floor area of approximately xx square metres

·         two bedrooms, one bathroom, kitchen, dining and living areas

·         no balcony

·         that it is located at the rear of the complex on the southern side of the middle level of the building.

It is proposed that in the new building you will:

·         own an apartment with a slightly larger floor area

·         have the same number of bedrooms, bathroom and living areas to the existing apartment

·         have a balcony

·         own one car parking space

·         have lift access

·         have an apartment located at the rear of the complex on the southern side of the property of a higher level of the building.

You will continue to have access to common areas such as the lobby and staircase. There is, and will be, no other communal areas.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 118-110

Reasons for decision

CGT event

A capital gain or capital loss is made when a CGT event happens to a CGT asset you own under section 102-20 of the ITAA 1997. A CGT asset is defined in section 108-5 of the ITAA 1997 and includes any kind of property. CGT assets include part of or an interest in property or 'a legal or equitable right that is not property'.

CGT event C2 happens when your ownership of an intangible CGT asset (such as contractual rights) ends. The time of the event is when you enter into a contract that results in the asset ending or, if there is no contract, when the asset ends. There are a number of ways such an asset can end, including being abandoned, surrendered or forfeited.

In this case when you sign a contract to demolish the property, CGT event C2 occurs. This is because you have an interest in the strata corporation based on the number of units you hold in the corporation. This is considered to be an intangible asset. You will require a valuation at the time that the contract is entered into to demolish the property to provide the market value of your unit at that time. You will make a capital gain at the time of entering into that contract where this valuation is more than the apartment's cost base.

Main residence exemption

Section 118-110 of the ITAA 1997 provides that you can disregard a capital gain or capital loss made from a CGT event that happens to a dwelling that is your main residence. To qualify for full exemption, the dwelling must have been your main residence for the whole period you owned it, the ownership period, and must not have been used to produce assessable income. You are only able to have one main residence at any one time.

The apartment was an investment and rented out from the time that it was purchased.

If you move into the apartment and establish it as your main residence you will be able to claim a partial main residence exemption when you dispose of or when it is demolished for the period of time that it was established as your main residence.

Profits from property sales

There are three ways profits from property sales can be treated for taxation purposes:

1. As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock.

2. As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of entering into a profit-making undertaking or scheme (including an isolated transaction).

3. As statutory income under the capital gains tax legislation.

Isolated profit making 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 case)).

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.

Paragraph 1 of TR 92/3 defines the term 'isolated transactions' as:

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

● 'those transactions entered into by non-business taxpayers'.

It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

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 taxpayers business but (TR 92/3 paragraph 6):

● 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.

The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

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 can be assessed as ordinary income within section 6-5 of the ITAA 1997.

Taking all of the available facts into consideration, the proceeds received from the sale of the additional apartments would be derived in the course of a one-off commercial transaction. The proceeds that the strata corporation will receive from the development of the apartment building are ordinary income and assessable under section 6-5 of the ITAA 1997.

Apartments owned by the strata corporation

A strata scheme is a legally recognised arrangement whereby a building and the land upon which it is erected is subdivided into lots, or lots and common property. The lots (commonly called units) have a separate title, which can generally be bought and sold without restriction. Common property is that part of a strata plan not comprised of any proprietor's lot and includes the stairways, lifts, passages, common gardening areas, and any other fixtures intended for common use.

The ownership of common property varies under different State Acts and Territorial Ordinances. In South Australia the ownership of common property is vested in the proprietors as per the schedule of unit entitlements and profits will be distributed on the basis of unit entitlement.

Taxation Ruling TR 2015/3 provides the Commissioner's view on income tax and 'matters relating to strata title bodies constituted under strata title legislation'. Where a strata title body distributes to apartment holders out of profits, it constitutes dividends which are assessable and can be franked (paragraph 33 of TR 2015/3).

When a disposal of an asset held under a strata title arrangement occurs in an isolated profit making transaction, each unit holder would receive income in line with their interest in the asset. Any income/loss would then be included in the assessable income of each lot holder.

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