Edited version of your private ruling

Authorisation Number: 1012593934197

Ruling

Subject: Property renovation isolated commercial transaction

Question and Answer

In respect to Property No 3, did you enter into a profit making activity of property renovations for which you can deduct the loss from your other assessable income?

No.

This ruling applies for the following period:

Year ended 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

During the year ended 30 June 20XX, you purchased the single storey Property No 3. Prior to the purchase you engaged a builder to give an estimate for a single storey renovation. At the time of purchase, your home address was Property No 2.

Following the purchase, you engaged an architect to assist with drafting plans, submissions to council and tendering to builders for a renovation. (The architect was the same that designed your renovations of Property No 2). A number of builder quotes were received. As a result of their cost, you decided to do a less substantial renovation and sold Property No 3 as soon as possible. You had major cash flow issues, particularly financing the loan, because you had left your job and because you were able to sell Property No 2 at your desired price. Property No 3 was sold x months after purchase and resulted in a significant loss.

At no time was Property No 3 rented out. The Property was at all times left vacant, due to the pending renovations. However, your private ruling application states you attempted to lease out the property while council application was in process but were not successful in securing a short term lease.

You have a history of real estate investment, which includes:

n Property No 1. Purchased in 200X. Sold in 200X. Despite your tax returns indicating it was rented immediately, you state you lived in the property for a few weeks before renting it for X years and then living in it and renovating it for the last few years before selling it tax-free as a main residence. During the rental period, you lived in a residence owned by extended family members.

n Property No 2. purchased in 200X. The property was not lived in prior to renting it for X years. After doing a significant renovation, you entered into a real estate agency agreement to sell the property by auction, a few weeks before buying Property No 3. The sale did not occur because you could not obtain the price you wanted. You and your extended family members remain living in it.

Reasons for decision

Summary

We consider you provided no compelling objective evidence to show Property No 3 had no use other than as the subject of trade. Your purchase of Property No 3 soon after (unsuccessfully) placing your primary residence (Property No 2) on the market for sale gives the impression Property No 3 could have had another use other than as the subject of trade, such as the type of rental and primary residence property characteristic of your previous property dealings, which you treated and would have likely treated as exempt or discounted capital gains.

Also, an impression gained is your transaction also did not have all of the qualities of a business-like transaction, it that its planning appeared ad hoc, disorganised and, ultimately, without independent financing, resulting in its liquidation.

Detailed reasoning

Taxation of property sales

There are three ways a loss on the disposal of property (real estate) can be treated for taxation purposes:

1. As a capital gains tax loss under Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997).

2. As a deductible loss under section 8-1 of the ITAA 1997 from carrying on a business of property development.

3. As a deductible loss under section 8-1 of the ITAA 1997 as a result of an 'isolated commercial transaction' entered into by a non-business taxpayer or by a business taxpayer outside the ordinary course of their business (as provided for in Taxation Ruling TR 92/4).

Ordinarily, a 'business' encompasses trade engaged in on a regular or continuous basis; whereas an isolated or one-off commercial transaction does not amount to a business but does have the characteristics of a business deal.

Isolated commercial transactions

Taxation Ruling TR 92/3 is about when profits on isolated transactions are of a commercial nature that fall on revenue account. Here, in relation to the disposal of property, paragraphs 9 and 49(g) state:

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, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations.

Some factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are…if the transaction involves the acquisition and disposal of property, the nature of that property (Edwards v. Bairstow; Hobart Bridge 82 CLR at 383). For example, if the property has no use other than as the subject of trade, the conclusion that the property was acquired for the purpose of trade and, therefore, that the transaction was commercial in nature, would be readily drawn.

Importantly, paragraph 7 of TR 92/3 states:

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.

Paragraph 13 of TR 92/3 states some matters which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are the following:

(a) the nature of the entity undertaking the…transaction;

(b) the nature and scale of other activities undertaken by the taxpayer;

(c) the amount of money involved in the…transaction and the magnitude of the profit sought or obtained;

(d) the nature, scale and complexity of the…transaction;

(e) the manner in which the…transaction was entered into or carried out;

(f) the nature of any connection between the relevant taxpayer and any other party to the…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.

Business-like transactions

Taxation Ruling TR 97/11 provides guidance on the features of a business operation. Paragraphs 68 to 70 of TR 97/11 state:

In Newton v. Pyke the court suggested that business should be conducted systematically. A business is characteristically carried on in a systematic and organised manner rather than on an ad hoc basis. An activity should generally conform with ordinary commercial principles to amount to the carrying on of a business.

In Ferguson the Full Federal Court was influenced by the systematic and organised nature of the taxpayer's activities. Fisher J said at FLR 324-325; ATC 4271; ATR 884:

'... the venture as a whole had a commercial flavour, was conducted systematically and, ... in a business like manner. It could not be said that there was anything haphazard or disorganised in the way in which he carried out the activity.'

In JR Walker Ryan J was satisfied, at ATC 4182; ATR 335, that the taxpayer was in the business of goat breeding as he had 'organised his activities in a business-like way through the keeping of books of account'.

The weight that is attached to this indicator will depend on the facts of the situation and a taxpayer may still carry on a business of primary production despite having poor organisational skills.

Accordingly, the www.ato.gov.au webpage titled Are you in the business of renovating properties? includes the criterion of business-like dealing in its example, as follows:

…your property renovating activities…are…planned, organised and carried on in a business-like manner…

Renovation as a profit-making activity

Fred and Sally are married with two children. They renovated their home, substantially increasing its value. After watching many of the home improvement shows and seeing how other people have bought, renovated and sold properties for a significant profit, they decide to investigate the purchase of another property to renovate and make a profit.

They consider many properties, costing out the renovations, costs of buying and selling, and time frames to complete the renovations. Their research shows that they also could make a significant profit.

They sell their current home and purchase a new property which they move into while completing the renovations. They plan out the renovation in stages, including the costs and any contractors needed to complete the work. The renovation runs to schedule and when completed they list the property for sale. The property sells for a profit.

As the property renovation were planned, organised and carried on in a business-like manner; the purpose of buying the property was to renovate it and make a profit; and the renovations were carried on in a similar manner to other property renovation businesses, Fred and Sally have entered into a one-off profit-making activity.

Application of law in your case

In your case, we consider you provided no compelling objective evidence (per paragraph 7 of TR 92/3) to show Property No 3 had no use other than as the subject of trade (per paragraph 49(g) of TR 92/3). Per paragraph 7 of TR 92/3, the determination in this private ruling is to be discerned from an objective consideration of the facts and circumstances of your case (rather than from your purported subjective intention and assertions).

Our objective consideration of the facts and circumstances of your case create the salient impression that you purchased Property No 3 under the assumption you would sell your primary residence (Property No 2) and, as a result, Property No 3 would become your primary residence.

Whilst the example of Fred and Sally (quoted above) does not prevent an isolated commercial transaction occurring to a property that has been also used as a primary residence, in your case, you have a history of using real estate for mixed residential, rental and renovation purposes (rather than buying, renovating and selling over a short time frame).

In other words, you have a history of occupying, renting and renovating properties in a manner that makes it difficult to not deem the resultant sale transaction as falling on capital account (from which you can take advantage of various CGT discounts and exemptions).

For example, it could be argued, using the principles (quoted above), that your intended sale of Property No 2 could have resulted in an isolated commercial transaction. However, because you have used Property No 2 for many purposes over a relatively long time period, such an argument would possibly be difficult to uphold.

Similarly, in the event that you did sell Property No 2, you have provided no compelling objective evidence that you would have used Property No 3 in a manner differently from how you used Property No 1 and Property No 2, so to bring about a property sale as exempt or discounted capital gains.

Thus, as initially stated, and unlike the example of Fred and Sally (quote above), you provided no compelling objective evidence to show that Property No 3 had no use other than as the subject of trade (per paragraph 49(g) of TR 92/3) and that the nature, scale and manner of your activity (per paragraphs 13(b) and (e) of TR 92/3) was different to that of your property renovations with Property No 1 and Property No 2, which you returned or would have returned on capital account.

In addition, to be isolated commercial transaction, it must be business-like. We consider your transaction did not have all of the qualities of a business-like transaction, in that it had some features of an ad hoc, haphazard or disorganised transaction (per paragraphs 68 to 70 of TR 97/11). Unlike the example of Fred and Sally, the costing out and research of your renovations, to show that they also could make a significant profit, was not done until after you bought the property. Crucially, you decided to not finance the transaction independently of the sale of Property No 2, which influenced you to liquidate Property No 3.

In conclusion, (per paragraph 7 of TR 92/3) the onus falls upon you to provide objective evidence that Property No 3 had no use other than as the subject of trade. Given the salient impression is you ideally wanted to sell Property No 2 to finance Property No 3 and given you have a history of conducting renovations and sales on capital account in a particular manner, we consider you have provided no evidence to demonstrate that your sale of Property No 3 should not be treated on capital account as a capital gains tax loss.