Edited version of private advice

Authorisation Number: 1052365827387

Date of advice: 26 February 2025

Ruling

Subject: CGT - cost base

Subject 1

Assessability of insurance compensation for property damage.

Question 1

Is the insurance compensation payment you received of $X assessable as ordinary income?

Answer

No

Question 2

Does the insurance compensation payment you received of $X reduce the cost base of your property for CGT purposes?

Answer

Yes.

Subject 2

Assessability of insurance compensation for loss of rental income.

Question

Is the insurance compensation payment you received for lost rental income of $X assessable as ordinary income?

Answer

Yes.

Subject 3

Deductibility of cleanup and strip out expenses.

Question

Are you entitled to claim a deduction for the $X you spent on the clean-up and strip of the property prior to selling it?

Answer

No.

This private ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You are a citizen of a foreign country. Since XXXX 20XX, you have been a permanent resident in Australia.

In 20XX, you bought the house (the property), as your main residence.

A few years ago, you had to leave Australia to look after some people due to their deteriorating health. You are currently living in their house looking after them which could take a few more years.

You decided to rent out the property during your absence. You continued to treat the property as your main residence for the period it was rented.

In December 20XX, in the aftermath of a natural disaster, the property was one of many properties that was severely flooded. Water was up to 160cm on the ground floor of the building, rendering it uninhabitable.

The tenants left the property immediately.

You initially tried to get repairs done through your insurance company, however that process was very lengthy and from the photos you had received as well as from assessor visits it was clear that there was still water in the house, creating mould and other damage.

In April 20XX, you were informed by the insurance company's builder that repairs would take at least another X months.

At that time, you decided to leave the people you were caring for and visit the property yourself to assess the damage and possibly get repairs organised or done by yourself. You spent X weeks in total at the site. You spent X weeks cleaning with the help of a few tradesmen. However, you realised that there was no way to get the property repaired in a reasonable timeframe. The people you were caring for were asking when you would return. You decided that the only way out was to sell the house.

You sold it at a discounted price within X weeks of putting it in the market. You received $X.

In addition to the payment for the property you got a substantial insurance payout of $X.

In addition, you received a separate insurance payout of $X for the loss of rental income.

You incurred expenses for the cleanup and strip out before the sale of $X.

You have supplied a market appraisal for the property of $X from a real estate agent for what it would have been worth without the flood damage.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 116-20

Reasons for decision

Issue 1

Assessability of compensation for property damage.

Question 1

Is the insurance compensation payment you received of $X assessable as ordinary income?

Summary

The insurance compensation payment you received of $X is not assessable as ordinary income.

Detailed reasoning

Under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) assessable income of an Australian resident includes income according to ordinary concepts (ordinary income) derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business. Other characteristics of income that have evolved from case law include receipts that:

•                     are earned

•                     are expected

•                     are relied upon, and

•                     have an element of periodicity, recurrence or regularity.

In your case, you received an insurance payout specifically for the damage to the property, because of the floods caused by a natural disaster. Therefore, the payment does not fit into any of the three categories of ordinary income listed above. It is a one-off payment without an element of recurrence or regularity and does not possess any of the other characteristics of ordinary income listed.

Accordingly, the payment is not assessable under section 6-5 of the ITAA 1997.

Question 2

Does the insurance compensation payment you received of $X reduce the cost base of your property for CGT purposes?

Summary

The insurance compensation payment you received will reduce the CGT cost base of your property. It will not be assessable as capital gains due to the main residence exemption.

Detailed reasoning

Section 116-20 of the ITAA 1997, provides the general rules about capital proceeds from a CGT event. Section

104-10 of the ITAA 1997 states that CGT event A1 happens if you dispose of a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law.

Taxation Ruling TR 95/35 Income tax: capital gains treatment of compensation receipts (TR95/35), at Paragraph 6 explains that if an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset of the taxpayer, and there is no disposal of that underlying asset at the time of the receipt, we consider that the amount represents a recoupment of all or part of the total acquisition costs of the asset. A post-CGT asset is one that the taxpayer as acquired after 20 September 1985.

Paragraphs 7 and 8 of TR 95/35 provide that the total acquisition costs of the post-CGT asset should be reduced by the amount of the compensation. No capital gain or capital loss arises in respect of the asset until the taxpayer actually disposes of the underlying asset. Therefore, there is no capital gain or loss at the time of receipt of the compensation amount.

In your case, the $X insurance compensation will reduce the cost base of your property for CGT purposes. However, as the property was your main residence for the whole of your ownership period, including the period it was rented it, there will be no CGT payable on the compensation.

Issue 2

Assessability of compensation for loss of rental income.

Question

Is the compensation payment you received for lost rental income of $X assessable as ordinary income?

Summary

The compensation for loss of rental income is considered to be ordinary income is assessable as ordinary income.

Detailed reasoning

Under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) assessable income of an Australian resident includes income according to ordinary concepts (ordinary income) derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

For income tax purpose, an amount paid to compensate for loss generally acquires the character for that which it is substituted.

A payment or benefit received by a taxpayer is included in your assessable income if it is:

•                     Income in the ordinary sense of the word, being ordinary income, or

•                     An amount or benefit that through the operation of the provisions of the tax law is included in assessable income, being statutory income.

The determination of the character of a payment and whether it is liable to tax, depends on the nature of the payment. A compensation payment to make up for lost earnings or in substitution for income which would otherwise have been earned is in the nature of income and is liable to income tax.

The lump sum amount you received of $ for the loss of rental income is income according to ordinary concepts because it replaces rental income you would otherwise have received. It is therefore assessable income under to section 6-5 of the ITAA 1997.

Issue 3

Deductibility of cleanup and strip out expenses.

Question

Are you entitled to claim a deduction for the $X you spent on the clean-up and strip of the property prior to selling it?

Summary

The expense is not deductible as it was not incurred in earning assessable income. It was incurred to enable you to sell the property. The expense forms part of the CGT cost base.

Detailed reasoning

Section 8-1 of the ITAA 1997 states that you can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income; or it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. However, you cannot deduct a loss or outgoing under this section to the extent that it is a loss or outgoing of capital, or of a capital nature; or it is a loss or outgoing of a private or domestic nature; or it is incurred in relation to gaining or producing your exempt income.

In your case, the $X expenses you incurred for the clean-up and strip of the property prior to selling it, is not deductible as it was not incurred in earning assessable income. It was incurred to enable you to sell the property.

However, the expense will form part of the CGT cost base of your property.

CGT cost base

The cost base of a CGT asset is generally what it cost you to buy it, plus other costs you incur to hold and dispose of it.

The second element of the cost base of a CGT asset includes incidental costs of acquiring the CGT asset or that relate to the CGT event - such as selling or disposing of the asset.

The incidental costs you may have incurred when you sell the asset include payment for services of preparing a property for sale.

The expense you incurred $X for the clean-up and strip of the property prior to selling it is not deductible as it was not incurred in earning assessable income. It was incurred to enable you to sell the property. The expense forms part of the CGT cost base of the property. However, as the property was your main residence for the whole of your ownership period, including the period it was rented it, the expense will be disregarded.

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