Edited version of private ruling

Authorisation Number: 1011872466704

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Ruling

Subject: Sale of rental investment property

Question 1

Will the profit on the sale of a rental property be assessable as revenue under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the profit on the sale of the rental property be assessable under section 102-5 of the ITAA 1997 as a capital gain?

Answer

Yes

This ruling applies for the following period:

The 2011-12 income year

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You purchased a block of land with the intention of demolishing the existing house and subdividing the block into three lots. You intended to hold one lot to build a rental investment and sell the other two lots, land only, for a profit.

You purchased this property with a loan.

You applied for an ABN and registered for GST.

You have only claimed GST input credits on the two lots being sold.

You paid the GST applicable on the sale when the first lot was sold.

You paid the GST applicable on the sale when the second lot was sold.

You recorded the profits from the sale of these two lots as revenue.

The proceeds from the sale of the two lots was used to pay out the loan.

A second loan was taken out for the construction costs for the rental property to be built on the third lot.

You have estimated the costs for construction of the rental house.

No input credits were claimed on the construction costs for the rental house.

You cancelled your ABN and deregistered for GST.

The rental property was rented out shortly after being completed.

The partners are considering selling the rental property to consolidate finances. You intend using the funds from the sale to pay off loans.

One partner is employed as a real estate manager and is a director of a company that buys and sells properties with the view of making a profit on the sale of those properties.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,
Income Tax Assessment Act 1997 Subsection 6-25(1),
Income Tax Assessment Act 1997 Section 15-15 and
Income Tax Assessment Act 1997 Section 102-5.

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Question 1

Summary

It is considered that the proceeds would not constitute ordinary income in terms of section 6-5 of the ITAA 1997, nor would they be assessable under section 15-15 of the ITAA 1997 as they are not considered to be a profit or gain arising from the carrying on or carrying out of a profit making undertaking or plan.

Detailed reasoning

Section 6-5 of the ITAA 1997 provides that your assessable income includes income according to ordinary concepts. This is called ordinary income.

An amount which is not assessable as ordinary income under section 6-5 of the ITAA 1997 may be included in your assessable income under section 15-15 of the ITAA 1997 if the profit arises from the carrying on or carrying out of a profit making undertaking or plan.

Profits made can be ordinary income if the activities become a separate business operation or commercial transaction.

For example, in Case W59 89 ATC 538; 20 ATR 3728 Deputy President Mr I.R. Thompson considered the appellant was carrying on a business of subdividing, developing and selling land. This was because the appellant had a significant degree of personal involvement in planning, negotiating with local councils and other bodies, obtaining finance, employing contractors, and selling the blocks. In addition to this the subdivision and development was substantial (the land had been divided into over 180 small blocks).

In order for the profit or gain from an isolated transaction to be assessable under section 6-5 of the ITAA 1997, the Commissioner has stated in Taxation Ruling (TR) 92/3 that the following two elements must be present:

· the intention or purpose of the 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 or in carrying out a business operation or commercial transaction.

The Commissioner considers that the following matters (listed at paragraph 13 of TR 92/3) may be relevant in determining 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 or the various steps in the transaction.

In your case:

· while the land was originally purchased to make a profit by subdividing and selling two blocks, the third block was retained with the intention of long term investment

· you took out a long term loan and constructed a rental property on the third lot

· the property has been rented since shortly after construction was completed

· you refinanced your loan with more attractive financing

· you are considering selling this property to consolidate finances

In summary, the third lot has been treated differently to the other two. The other two lots were sold as vacant land as soon as practicable. This lot was retained. You took out a long term loan for the construction costs, which indicates a long term investment. The property was rented as soon as practicable, and has been continually rented for years. You refinanced your loan also indicating a long term investment.

On balance, all evidence suggests that the property was intended to be a long term investment. As such, the making of a profit is not considered to be the motivation in entering into the transaction.

Accordingly it is considered that the proceeds would not constitute ordinary income in terms of section 6-5 of the ITAA 1997, nor would they be assessable under section 15-15 of the ITAA 1997 as they are not considered to be a profit or gain arising from the carrying on or carrying out of a profit making undertaking or plan.

Question 2

Summary

The sale of the property would be CGT event A1. The capital gain or capital loss on the disposal of this property would need to be included in the calculation of your net capital gain for the relevant income year. Your assessable income includes any net capital gain for the income year.

Detailed reasoning

Division 100 of the ITAA 1997 explains that you make a capital gain or a capital loss if a CGT event happens to a CGT asset. Subsection 100-25(2) of the ITAA 1997 specifically includes land and buildings as CGT assets. Disposal of a CGT asset is CGT event A1 (section 104-5 of the ITAA 1997).

You currently have possession of a property. This property has been used as an investment, earning rental income for a few years. You are considering selling this property.

This property is a CGT asset. The sale of the property would be CGT event A1. The capital gain or capital loss on the disposal of this property would need to be included in the calculation of your net capital gain for the relevant income year. Section 102-5 of the ITAA 1997 includes any net capital gain for the income year in your assessable income.