Edited version of your private ruling

Authorisation Number: 1012261972518

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Ruling

Subject: Disposal of land - income v capital

Question 1:

Are the proceeds of the sale of the subdivided residential lots, under alternative 1 or 2, assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as ordinary income?

Answer:

No

Question 2:

Are the proceeds of the sale of the subdivided residential lots, under alternative 1 or 2, assessable under the capital gains tax (CGT) provisions of the ITAA 1997?

Answer:

Yes

Question 3:

Are you entitled to fully disregard any capital gain made on disposal of the dwelling (and adjacent 2 hectares of land) due to the main residence CGT exemption, as long as the dwelling is disposed of within two years of the date of the deceased's death?

Answer:

Yes

Question 4:

If the dwelling is not disposed of within two years of the date of the deceased's death, will the first element of the cost base of the dwelling (and adjacent 2 hectares of land) for the pre-CGT interest in the asset, be equal to the market value of the asset at the date of the deceased's death?

Answer:

Yes

Question 5:

If the dwelling is not disposed of within two years of the date of the deceased's death, will the first element of the cost base of the dwelling (and adjacent 2 hectares of land) for the post-CGT interest in the asset, be equal to the deceased person's cost base of the asset at the date of the deceased's death?

Answer:

Yes

This ruling applies for the following period

Year ended 30 June 2014

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of, and are to be read, with this description. The relevant documents are:

· the application for private ruling dated 10 July 2012

· copy diagram and certificate of title

· copy of Grant of probate

· copy of deceased's will

· copy of feasibility study

· copy of subdivisional and development plan

You are the sole beneficiary in the estate of your late parent. You will become registered as the sole owner of the properties compromising a number of lots.

All of the lots were acquired prior to 1985.

When each of the lots were acquired, they were zoned for use as single residential. The area has since been rezoned permitting creation of smaller lots per dwelling and also for development of multiple dwellings.

Your parents both occupied the dwelling on one of the lots from shortly after the date of acquisition as their main residence. The occupancy continued uninterrupted until the death of one of your parents, and continued thereafter until your remaining parent moved to a nursing home. The lot was never used to produce assessable income and has remained unoccupied since your remaining parent moved to a nursing home.

When your first parent died, your remaining parent became sole owner of the lots.

When your remaining parent died probate of their will named you as sole executor and beneficiary of their estate.

You intend to retain ownership of the dwelling on one of the lots as a long term investment. You may choose to sell the property or it may pass to your children upon your death. However, until then it will be leased out and produce assessable income. The lot is a large area of land and you intend to dispose of that part of it not required for the dwelling.

The other lots were acquired as long term investments from which your parent (as the surviving owner) and now the estate of your parent derived assessable income by leasing out the dwellings on those lots. You intend to dispose of these lots in the most advantageous way.

You have considered selling the lots and have sought professional advice on the most advantageous way to realise part of one of the lots and all of the remaining two lots.

There are two alternatives currently being considered. Both alternatives have been considered in providing this ruling and the ruling provided relates to either of the below proposed alternatives.

Alternative 1

Obtaining a subdivisional approval to subdivide into 10 vacant strata lots with an integrated development plan as to dwellings capable of being constructed on each lot and you will be selling the land with that integrated subdivisional plan and development approved and with provision for the separate lot, on which your parents' former dwelling stands, to be transferred back to you.

Alternative 2

Obtaining a subdivisional approval to subdivide into 10 vacant strata lots with the integrated development plan as to dwellings and you will be arranging for the essential subdivisional works to be carried out to satisfy the subdivisional approval and then you will sell each subdivided lot (with the benefit of the development approval as to the dwelling that the purchaser could construct on the relevant lot) and you will be retaining the separate lot on which the your parents' former dwelling stands.

You have arranged for a firm of architectural draftsmen to prepare and lodge a subdivisional plan, as to creation of 10 lots together with a lot compromising part of the land from the lot that was your parents' former dwelling and land, and a development plan integrated to the subdivision for 12 dwellings (compromising 9 house units and 3 apartments).

You will not have any personal or direct involvement in undertaking and of the ongoing process of obtaining the subdivisional approval or development approval nor in any of the subdivisional works. All of the process will be undertaken by professionals engaged by you and all subdivisional works will be undertaken by contractors engaged by you. You intend to engage a real estate agent to carry out all promotion of sale of the lots and for negotiations for such sales. You may represent yourself in the settlement of the sale of the lots or hire a solicitor.

To this date, demolition and clearing of vegetation has commenced by contractors engaged by you, but otherwise no works have been undertaken to prepare the land for sale or subdivision. You, through engaged professionals, have undertaken those tasks necessary to place a subdivisional application and development application before the local council.

Your activities thus far have been:

· preparation of feasibility

· preparation of subdivisional plan and development plan and associated site survey of the 3 lots

· submission to the local council of an application for approval of the subdivisional plan and development plan and discussions with the council on progress of the application.

Alternative 1 - Works require engaging professionals to:

· preparation of the subdivisional plan and development plan

· preparation of the application to council for the approval

· discussion with council planning personnel

· promotion of sale of the land

· settlement transfer of the land to a purchaser (with a transfer back to you of the subdivided lot upon which will be situated the former dwelling of your parents).

Alternative 2 - Works require engaging professionals to:

· same as mentioned in alternative 1, and;

· lodgement of subdivisional plan with an application for separate titles for the subdivided lots

· promotion of sale of separate subdivided lots and settlement transfer of the separate lots to purchasers (with you retaining title to the separate subdivided lot upon which will be situated the former dwelling of your parents)

· development works of the land that will do no more than required by the council for it to approve the subdivisional plan for lodgement to obtain separate titles for each subdivided lot. This will be works in the construction of an access road, draining, electricity, gas, water and sewerage.

· the land will be divided into 10 lots (and a lot compromising part of the land that was your parents' former dwelling and land) with an access road internal to the subdivision. No buildings will be constructed on the lots as part of the development. You intend to make some repairs and renovations on you parents' former dwelling.

· the whole process is expected to take approximately 9 months, although the timing of promotion and sales may depend on prevailing market conditions.

You will fund all the works and activities undertaken by the professionals. Or, external borrowings for the development will be kept to a minimum and if financed, no interest or other 'revenue account' deductions will be claimed by you.

The development costs and estimated gross sales revenue has been provided in your ruling application.

You have no history of land or property development. You have not been nor have any expectation of being involved in any subdivision of land development activities.

You state that the land was acquired under the will of your late parent and therefore you had no purposive intent in the acquisition of the land.

You state that you have no profit making purpose but merely seek to realise the land in the most advantageous way having regard to the independent advice received from the feasibility.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 112-25

Income Tax Assessment Act 1997 Section 118-195

Income Tax Assessment Act 1997 Section 118-145

Income Tax Assessment Act 1997 Section 118-120

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 110-35

Income Tax Assessment Act 1997 Subsection 112-25(3)

Income Tax Assessment Act 1997 Subsection 128-15(4)

Income Tax Assessment Act 1997 Subsection 128-15(5)

Reasons for decision

Detailed reasoning

It needs to be determined whether the proceeds from the sale of the subdivided residential blocks:

· is assessable ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as you were carrying on a business of property development

· is assessable ordinary income under section 6-5 of the ITAA 1997 as you conducted an isolated commercial transaction with a view to a profit, or

· is a mere realisation of a capital asset and assessable under the capital gains tax (CGT) provisions.

Assessable as ordinary income

Income from carrying on a business of property development

The question of 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 facts provided.

Taxation Ruling TR 97/11 provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. Indicators include commercial significance or character, regularity and repetition, organisation, size, scale and permanency.

No one factor is decisive. The indicators must be considered in combination and as a whole. Whether a 'business' is carried on depends on the large or general impression gained.

From the facts provided, and in applying the business indicators to your circumstances, we make the following observations:

· you have not previously been engaged in property development

· you do not intend to commence a property development business

· you have had minimal involvement in the construction and sales processes for the development (as you are engaging other parties for these purposes).

· this is a one-off activity that is unlikely to be repeated.

Therefore, the large and general impression gained after examining your activity against the business indictors identified in TR 97/11, is that you are not considered to be carrying on a business of property development.

Income from an isolated transaction

Paragraph 234 of Miscellaneous Taxation Ruling MT2006/1 distinguishes between a business and an adventure or concern in the nature of trade (or profit-making undertaking or scheme). It provides that the term 'business', would encompass trade engaged in, or on, a regular or continuous basis. However, it goes on to say that an adventure or concern in the nature of trade may be an isolated or one-off transaction that does not amount to a business deal but has the characteristics of a business deal.

The question of whether an entity is carrying on an enterprise often arises where there are one-off property transactions. The decision to be made is whether the activities are an adventure or concern in the nature of trade as opposed to the mere realisation of a capital asset.

Taxation Ruling TR 92/3 sets out the Commissioners view on whether profits made from isolated transactions are ordinary income. '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.

Whether a profit from an isolated transaction is income according to ordinary concepts depends very much on the circumstances of the case. However, where a taxpayer who does not carry on a business makes a profit from an isolated transaction, that profit is income if:

· 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.

Intention or purpose

The relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

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.

In your case, you acquired the lots in question through being a beneficiary of your late parent's will and therefore the land was not acquired with the purpose of re-selling the land for profit. In addition, you have not been involved in property development before and do not intend to commence such an operation. You provide that you only wish to realise the assets in the most advantageous way. Accordingly, it is reasonable to conclude that there was no profit making intention present when entering into the development transaction.

Carrying out a commercial transaction

For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character. Paragraph 13 of TR 92/3 lists factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction. Relevant factors 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;

· 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.

In addition to the above general factors, MT 2006/1 provides a list of specific factors relevant to real property and development, if several of these factors are present it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows:

· there is a change of purpose for which the land is held;

· additional land is acquired to be added to the original parcel of land;

· the parcel of land is brought into account as a business asset;

· there is a coherent plan for the subdivision of the land;

· there is a business organisation - for example a manager, office and letterhead;

· borrowed funds financed the acquisition or subdivision;

· interest on money borrowed to defray subdivisional costs was claimed as a business expense;

· there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

· buildings have been erected on the land.

No single factor is determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

In your case, the development consists of demolishing the existing rental properties on the lots and subdividing the original lots of land into 10 lots. You intend to conduct works on the lots by construction of an access road, drainage, electricity, gas, water and sewerage. This is to be undertaken in order to gain the necessary subdivision approvals.

The magnitude of the profit from the activity is likely to be significant and the activity is similar to the type that a property developer would conduct, since you are developing the land in an organised and professional manner with a coherent plan for the subdivision of land. However, your proposed development does not involve many of the specific factors that may be considered determinative in finding that the development to be carried out has the character of a commercial transaction.

Based on the information provided, it appears that you do not intend to undertake any development of the land beyond what is required to secure approval of the subdivision (and dwelling approvals) and enhance the presentation of individual allotments.

Accordingly, as the transaction does not appear to be commercial in character and no profit making intention was considered present when entering into the development, the transaction is considered to be a mere realisation of a capital asset/s, in the most advantageous manner.

Assessable as a capital gain

Disposal of a CGT asset

Section 104-10 of the ITAA 1997 provides that CGT event A1 occurs when your ownership in a CGT asset (eg. property) is transferred to another entity. The time of the event is when you enter into a contract for the disposal, or, if there is no contract, the time of disposal is taken to be the time when the change in ownership occurs. In your case, you will dispose of a CGT asset (the property), therefore CGT event A1 will happen and the capital gains tax provisions will apply.

Section 112-25 of the ITAA 1997 provides that when a CGT asset is split into two or more assets, such as when you subdivide a block of land into three separate blocks, the split or change is not a CGT event. Therefore, it is only on disposal of the CGT asset that a CGT event will occur.

Death and the main residence exemption

Section 118-195 of the ITAA 1997 provides that if the deceased died on or after 20 September 1985 but, had acquired the dwelling before 20 September 1985 and you have an ownership interest in a dwelling that passed to you as a beneficiary in a deceased estate, or you have owned it as trustee of a deceased estate, you disregard any capital gain or capital loss you make from a capital gains tax (CGT) event that happens to the dwelling if either of the following applies:

· You disposed of your ownership interest within two years of the person's death, or

From the deceased's death until you disposed of your ownership interest, the dwelling was not used to produce income and was the main residence of one or more of:

· a person who was the spouse of the deceased immediately before the deceased's death (but not a spouse who was permanently separated from the deceased)

· an individual who had a right to occupy the home under the deceased's will

· you, as a beneficiary, if you disposed of the dwelling as a beneficiary.

Section 118-145 of the ITAA 1997 provides that the main residence of an individual can continue to be regarded as the main residence of the individual despite the fact that the individual no longer lives in it. If the dwelling is not used to produce income (for example, you leave it vacant, or use it as a holiday home) you can treat the dwelling as the main residence for an unlimited period. If the dwelling is used to produce income (for example, you rent it out or it is available for rent) you can choose to treat it as your main residence for up to six years after you cease living in it. In addition, if the deceased was not living in the home at the date of their death, they or their trustee may have chosen to continue to treat it as their main residence. This may happen if, for example, the person moved to a nursing home

Section 118-120 of the ITAA 1997 provides that the land adjacent to a dwelling is also exempt if:

· during the period you owned it, the land is used mainly for private and domestic purposes in association with the dwelling, and

· the total area of the land around the dwelling, including the land on which it stands, is not greater than 2 hectares. If the land used for private purposes is greater than 2 hectares, you can choose which 2 hectares are exempt but the land you choose must include the land on which the dwelling is built.

Any part of the land around a dwelling used to produce income is not exempt, even if the total land is less than 2 hectares. However, the dwelling and any buildings and other land used in association with it remain exempt if you do not use them to produce income.

In your case, your parents jointly purchased a number of lots prior to 20 September 1985, with the dwelling on one lot being the main residence of your parents. One of your parents passed away and your remaining parent became sole owner of the lots. At this date your remaining parent owned a 50% interest in each lot, acquired pre-CGT and a 50% interest in each lot, acquired post-CGT (on the death of your first parent).

Your remaining parent continued to reside in the dwelling on one of the lots until they moved to a retirement home, and subsequently passed away. After you parent passed away, you attained ownership of the properties as you were named sole executor and beneficiary of your parent's estate.

Accordingly, you may continue to treat the dwelling on the lot (and up to 2 hectares of adjacent land) as the main residence of your parent up until the date of their death. In addition, the main residence exemption will also apply to you, as sole beneficiary of your parent's estate, as long as you dispose of your ownership interest within two years of the date of your parent's death.

Death and the cost base of a CGT asset

In situations where a beneficiary of a deceased estate does not dispose of their ownership interest in the CGT asset within two years of the date of death, the beneficiary will be assessed on any capital gain made on the disposal of the CGT asset.

You make a capital gain from the disposal of an asset if the amount of money you received on the disposal was more than the cost base of the asset.

Section 110-25 of the ITAA 1997 provides that there are five elements of the cost base;

· money paid, or market value of property given, to acquire the asset

· incidental costs of acquiring the asset, or that relate to the CGT event that happens to the asset

· certain non-capital costs of ownership

· capital expenditure on improvements

· capital expenditure in respect of title or right to the asset

Section 110-35 of the ITAA 1997 provides that incidental costs include remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser.

Subsection 112-25(3) of the ITAA 1997 explains how to calculate the cost base of an asset that has been created by splitting the original asset into 2 or more new assets. It provides that the cost base of each new asset should be calculated as follows:

· Work out each element of the cost base of the original asset at the time of the event that split the original asset.

· Apportion in a reasonable way each element to each new asset. The result is each corresponding element of the new asset's cost base.

Subsection 128-15(4) of the ITAA 1997 explains modifications to the cost base of CGT assets for legal representatives or beneficiaries of deceased estates. It provides that if the deceased person acquired their asset before 20 September 1985, the first element of your cost base and reduced cost base is the market value of the asset on the day the person died. However, if a deceased person acquired their asset on or after 20 September 1985, the first element of your cost base and reduced cost base is taken to be the deceased person's cost base and reduced cost base of the asset on the day the person died.

As a beneficiary, under subsection 128-15(5) of the ITAA 1997, you can include in your cost base (and reduced cost base) any expenditure the legal personal representative (for example, the executor) would have been able to include in their cost base if they had sold the asset instead of distributing it to you. You can include the expenditure on the date they incurred it.