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Ruling

Subject: Rental property

Question and Answer

1. Are you entitled to the main residence exemption?

Yes.

2. Can you claim the removal of trees, levelling of building site and landscaping in the cost base as capital expenses?

Yes.

3. Can you offset your capital loss from the sale of shares against any capital gain?

Yes.

This ruling applies for the following period

1 July 2010 to 30 June 2011

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Post 20 September 1985 the taxpayer and spouse purchased an investment property.

The taxpayers rented out the property.

The taxpayer's child lived in the property for a period of time and applied to the council to rebuild the house.

The taxpayer separated from the spouse and moved into the investment property.

The council approved the taxpayer's development application for a duplex subdivision.

The taxpayer signed the building contract.

The demolition of the house began and the taxpayer moved in with a relative.

The taxpayer signed consent orders with the local court to retain the property.

The final consent orders issued.

The family court settlement for divorce was finalised and the taxpayer has full ownership of the property.

The property is now a duplex. The left side of the duplex's interior was completed first and the electricity for both units was finished at almost the same time.

The taxpayer incurred costs in relation to removal of trees, levelling the building site and landscaping.

The taxpayer moved into the duplex to live in the left side and elect it as a main residence.

The taxpayer rents out the right hand side unit and moves to live with a relative.

The taxpayer's child lives in the left hand side unit and does not pay rent.

The taxpayer's child moves from the left hand side unit and it is rented out.

The final building inspection is conducted and approval is given.

The taxpayer receives the occupation certificate.

The council allocates the house numbers.

The titles are split for the duplex. The duplex is split 50/50 with equal amount of land and own accesses.

The taxpayer moves back to the property.

The taxpayer amends the electoral role to the new address.

The taxpayer signs a contract to sell the unit on the left hand side.

Settlement takes place.

Shares

In the late 1980s you incurred a capital loss on disposal of another asset.

The asset was in your name only.

You have not had any previous capital gains.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 102-5(1)

Income Tax Assessment Act 1997 Subsection 102-10(2)

Income Tax Assessment Act 1997 Subsection 102-15(1)

Income Tax Assessment Act 1997 Subsection 102-15(2)

Income Tax Assessment Act 1997 Subsection 102-15(3)

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-20

Income Tax Assessment Act 1997 Subsection 108-5(2)

Income Tax Assessment Act 1997 Section 112-30

Income Tax Assessment Act 1997 Section 126-5

Income Tax Assessment Act 1997 Section 118-110

Income Tax Assessment Act 1997 Subsection 118-145(1)

Income Tax Assessment Act 1997 Section 118-150

Income Tax Assessment Act 1997 Subsection 118-150(3)

Income Tax Assessment Act 1997 Section 118-185

Reasons for decision

Capital gains tax (CGT) is the tax the taxpayer pays on certain gains they make. Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) states, the taxpayer makes a capital gain or a capital loss as a result of a CGT event happening.

Where an interest in an asset is transferred to a former spouse or de facto spouse as a result of a marriage breakdown, CGT event A1 occurs. The time of the event is the time the taxpayer enters into a contract for disposal of the asset, or if there is no contract, the time at which ownership changes.

Marriage or relationship breakdown roll-over

In certain situations, a capital gain or capital loss made as a result of a CGT event can be disregarded or rolled over.

Section 126-5 of the ITAA 1997 provides an automatic roll-over if the taxpayer transfers an asset to a spouse (including a de facto spouse) as a result of a marriage or relationship breakdown.

For roll-over to apply under section 126-5 of the ITAA 1997, the transferor spouse must transfer the asset because of:

§ a court order under the Family Law Act 1975 (FLA) or a corresponding foreign law; or

§ a maintenance agreement approved by a court under section 87 of the FLA; or

§ a court order under a State law, Territory law or foreign law relating to de facto marriage breakdowns.

This roll-over allows the spouse transferring the asset (the transferor) to disregard a capital gain or capital loss that would otherwise arise as a result of the transfer.

Where marriage breakdown roll-over relief applies, the transferee spouse is taken to have acquired the asset at the time of the transfer. The first element of the cost base or reduced cost base of the asset is the transferor's cost base at the time of the transfer.  

Marriage breakdown roll-over relief would apply to a former spouse under section 126-5 of the ITAA 1997, because they have transferred their ownership interest in the property to the taxpayer under a marriage settlement that was the subject of a family court order.

The taxpayer is taken to have acquired the former spouse's share of the property at the time of the transfer, and the cost base of each property will be the cost base of the former spouse's share in the property at the time of the transfer.

Any capital gain or capital loss made at the time of transfer of the property is deferred until such time as the taxpayer (the transferee) disposes of the property. Therefore, a capital gains tax event will not arise at the time of the transfer of the property by the former spouse.

Dwelling not main residence for the entire period of ownership

The disposal of the taxpayer's unit has triggered CGT event A1 (section 104-10 of the ITAA 1997).

Generally, the taxpayer can ignore a capital gain or capital loss from a CGT event that happens to a dwelling that is their main residence for the entire period they owned it (section 118-110 of the ITAA 1997).

Section 118-185 restricts the relief where a dwelling was not the main residence for whole of the taxpayer's period of ownership. It operates on a time basis, i.e. the capital gain or capital loss is calculated on the basis of the number of days when the dwelling was not a main residence compared to the number of days of ownership of the dwelling.

A taxpayer will only get a partial exemption for a CGT event that happens in relation to a dwelling or their ownership interest in it if:

§ the taxpayer is an individual

§ the dwelling was their main residence for only part of their ownership period; and

§ the interest did not pass to them as a beneficiary in, or as a trustee of, the estate deceased person.

The capital gain (CG) or capital loss (CL) is adjusted using the following formula:

CG or CL amount x Non-main residence days

Days in the ownership period

where:

CG or CL amount is the capital gain or capital loss a taxpayer would have made from the CGT event apart from this subdivision. That is the CG or CL calculated as if no main residence exemption was available.

Non-main residence days are the number of days during which the residence was not the taxpayer's main residence in the ownership period.

The property was not the taxpayer's main residence for the whole period they owned it. From the time the taxpayer purchased the property till when the taxpayer started to live in the property, they are not entitled to the main residence exemption.

Main residence exemption - six year rule

Subsection 118-145(1) of the ITAA 1997 allows the taxpayer to choose to treat a dwelling as their main residence even though they no longer live in it. The taxpayer cannot make this choice for a period before a dwelling first becomes their main residence.

This choice needs to be made only for the income year that a CGT event happens to the dwelling that is, the year that the taxpayer enter into a contract to sell it. If the taxpayer makes this choice, they cannot treat any other dwelling as their main residence for that period (except for a limited time if the taxpayer is changing residences).

If the taxpayer uses the dwelling to produce income they can choose to treat it as their main residence for up to six years after they cease living in it. If the taxpayer is absent more than once during the period they own the home, the six-year maximum period that the taxpayer can treat it as their main residence while they use it to produce income applies separately for each period of absence.

The taxpayer elected the property as their main residence, when they started to live in the house to when they signed the contact to sell the property.

The taxpayer rented out both units and while they lived with relatives. The taxpayer moved back to the property within the six year period. The taxpayer did not choose any other dwelling as their main residence.

The taxpayer is entitled to the main residence exemption for the period they were absent under the six year rule.

Demolition of a Dwelling

Section 104-20 of the ITAA 1997 provides that capital gains tax (CGT) event C1 happens if a CGT asset owned by a taxpayer is lost or destroyed.  Subsection 108-5(2) of the ITAA 1997 allows this event to happen to part of a CGT asset.

The demolition of a house would fall within the definition of destruction for the purpose of CGT event C1.

CGT event C1 happens when the destruction occurs.

In the case of a part disposal of an asset, the cost base and reduced cost base of the building would be calculated in accordance with section 112-30 of the ITAA 1997.

Applying the formula the cost base of the building is nil. The cost base of the remaining part will be the cost base/reduced cost base of the asset just before demolition.

Note: If a building is demolished, there is no deemed market value consideration for the disposal that occurs as a result of the demolition.  This is because the market value substitution rules do not apply where CGT event C1 occurs.

Cost base

The cost base of a CGT asset is made up of five elements (section 110-25 of the ITAA 1997);

1. money or property given for the asset

2. incidental costs of acquiring the CGT asset or that relate to the CGT asset

3. cost of owning the asset

4. capital costs to increase or preserve the value of your asset or to install or move it

5. capital costs of preserving or defending your ownership of or rights to your asset

Fourth element: capital costs to increase or preserve the value of your asset or to install or move it

The fourth element is capital costs the taxpayer incurred for the purpose, or the expected effect, of increasing or preserving the asset's value - for example, costs incurred in applying (successfully or unsuccessfully) for zoning changes. It also includes capital costs the taxpayer incurred that relate to installing or moving an asset.

However, it does not include capital expenditure incurred in relation to goodwill, which may be deductible as a business related cost.

The expenditure for the removal of trees, levelling the building site and landscaping can be included in the fourth element of the cost base as the taxpayer is increasing the value of the asset.

Offsetting losses

Subsection 102-5(1) of the ITAA 1997 provides that a taxpayer's assessable income includes any net capital gain accrued to the taxpayer during the year of income.

The net capital gain that accrues to the taxpayer is the sum of all capital gains accrued to the taxpayer during the year of income less the sum of all capital losses incurred during the year of income and of any net capital loss carried forward from the preceding year.

Subsection 102-10(2) of the ITAA 1997 states that the taxpayer cannot deduct a net capital loss from their assessable income for any income year.

Subsection 102-15(1) of the ITAA 1997 states that in working out if the taxpayer has a net capital gain, their net capital losses are applied in the order that they made them.

Subsection 102-15(2) of the ITAA 1997 states that a net capital loss can only be applied to capital gains once.

Subsection 102-15(3) of the ITAA states that when a net capital loss cannot be applied in an income year, it can be carried forward to a future income year.

The taxpayer has a capital loss from an earlier year in relation to the sale of an asset, the asset was in their name only and they have not incurred a capital gain in any previous years. The taxpayer may offset the capital loss, from the sale of the asset, against any capital gain.