Edited version of your written advice

Authorisation Number: 1012807107071

Ruling

Subject: Sale of property

Question 1

Is the income from the sale of your units assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Does the market value of the property at the time of entering into the property development form part of your cost in calculating the profit on the sale of each subdivided lot?

Answer

Yes.

Question 3

Will the capital gains tax provisions apply in relation to the sale of the subdivided lots?

Answer

Yes.

Question 4

Will any capital gains be reduced by the amount assessable under section 6-5 of the ITAA 1997?

Answer

Yes.

Question 5

Are you entitled to the 50% discount in relation the capital gain made on the sale of your units?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commenced on

1 July 2012

Relevant facts

You and your spouse had a long term rental property held as joint tenants.

You owned the property for several years.

A couple of years ago, the tenants moved out.

You demolished the house and built residential units. The land was subdivided with you both remaining joint owners. The units were sold shortly after completion.

You have never been in the business of property development.

You appointed a building company to manage the project.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 6-10.

Income Tax Assessment Act 1997 Section 102-20.

Income Tax Assessment Act 1997 Section 104-20.

Income Tax Assessment Act 1997 Section 108-55.

Income Tax Assessment Act 1997 Section 108-70.

Income Tax Assessment Act 1997 Section 109-5.

Income Tax Assessment Act 1997 Section 112-25.

Income Tax Assessment Act 1997 Section 118-20.

Income Tax Assessment Act 1997 Division 115.

Reasons for decision

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Under section 6-10 of the ITAA 1997, assessable income also includes statutory income.

Generally, if the sale of land constitutes a business or part of a business or a commercial transaction, then the proceeds will be assessable as ordinary income under section 6-5 of the ITAA 1997. On the other hand, if the sale is mere realisation of the land, the proceeds will be a capital amount. 

In certain circumstances profits from isolated transactions are considered to be ordinary income.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5 of the ITAA 1997.

The term isolated transaction refers to:

(a) those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

(b) those transactions entered into by non-business taxpayers.

We consider that your transactions are isolated transactions as referred to in category (b) above.

If a taxpayer not carrying on a business makes a profit from an isolated transaction or operation, that profit is assessable income if both of the following elements are present:

1.     the intention or purposes of the taxpayer in entering into the transaction or operation was to make a profit or gain; and

2.     the transaction or operation was entered into and the profit was made in carrying out a business operation or commercial transaction.

Profit-making does not need to be the sole or dominant purpose for entering the transaction. A profit-making purpose must exist at the time the transaction or operation was entered into.

In your situation, the land and rental property had been held for several years. After several years of renting, you decided to demolish the existing house and build units.

Although you are not in the business of property development, to decide if any profit you make is income, we need to consider if the transaction was entered into, and the profit was made in carrying out a business operation or commercial transaction.

For a transaction to be characterised as a business operation or commercial transaction, it is sufficient if the transaction is business or commercial in nature.

TR 92/3 lists the following as some matters which may be relevant in considering 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 and the various steps in the transaction.

In considering whether your transaction amounts to a business operation or commercial transaction, the following matters are relevant:

• You are individual non-business taxpayers who owned a rental property for several years.

• You appointed a building company to manage your project.

• The building of the units took place after the tenants moved out.

• The nature scale and complexity of the operation is significant.

Although you have never been in the business of property development, it is not considered the transactions to be a mere realisation of an asset. You did more than just sell your property once the tenant moved out. Rather you decided to demolish the existing house, subdivide the property and then build units.

After objective consideration of these matters, we have determined that the construction and sale of the units has the characteristics of a commercial transaction. That is, your transactions and the level of development go beyond that of a mere realisation of a capital asset.

The sale is assessable as profit from an isolated transaction and any profit made on the sale of the two units form part of your assessable income under section 6-5 of the ITAA 1997.

Cost of transaction

In situations where the sale of an asset is not a mere realisation, it is the net profit from the isolated transaction which will be assessable as ordinary income - see FC of T v. Whitford Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031.

In determining the net profit that will arise from the sale of your units, the sale proceeds are reduced by an appropriate amount based on the market value of the block at the time the land was ventured into the profit-making scheme.

You will therefore be able to use the market value of the property at the time of entering into the unit development in calculating the profit on the sale of each subdivided lot.

Capital gains tax provisions

Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is made only if a capital gains tax (CGT) event happens.

Demolition of a Dwelling

CGT event C1 happens if a CGT asset you own is lost or destroyed.

Taxation Determination TD 1999/79 Income tax: capital gains: does the expression 'lost or destroyed' for the purposes of CGT event C1 in subsection 104-20(1) of the Income Tax Assessment Act 1997 apply to (a) a voluntary 'loss' or 'destruction'? (b) intangible assets? confirms that CGT event C1 can happen on the voluntary destruction of an asset where for example, a taxpayer might demolish a building in the course of redeveloping a property. Therefore, upon the demolition of the dwelling CGT event C1 will occur.

Subsection 104-20(3) of the ITAA 1997 provides that you make a capital gain from CGT event C1 if the capital proceeds from the loss or destruction are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced coat base. Section 116-25 of the ITAA 1997 provides that the market value substitution rule does not apply to CGT event C1. When a CGT event happens to only part of an asset, you are required to apportion the cost base or reduced cost base between the entire CGT asset using the apportionment rules in subsections 112-30(2), (3) and (4) of the ITAA 1997.

Because you did not receive any capital proceeds upon the demolition of the house, the combined effect of these provisions is that no amount is apportioned to the cost base or reduced cost base of the house. As the capital proceeds from the demolition were nil and the cost base attributed to the house is also nil, you will not make a capital gain or capital loss upon the demolition of your house.

Subdivision

Section 112-25 of the ITAA 1997 considers the treatment of split, changed or merged assets for CGT purposes. Section 112-25 of the ITAA 1997 states that if a CGT asset (the original asset) is split into two or more CGT assets (the new assets) and you are the beneficial owner of the original asset and each new asset, the splitting is not a CGT event. In order to work out the cost base of each new asset it is necessary to work out each element of the cost base and reduced cost base of the original asset and apportion in a reasonable way each element to the new asset.

In your case you are the owner of the original block of land and house and you are also the owner of each new subdivided lot. Therefore no CGT event occurs on subdividing your property.

Land and a house constructed on that land are generally taken to be a single asset. However, a building will be treated as a separate asset from the land to which it is affixed if the building is a depreciating asset for which a balancing adjustment must be worked out upon disposal, or the building is acquired/constructed after 20 September 1985, and the land to which it is affixed to was acquired prior to 20 September 1985 (sections 108-55 and 108-70 of the ITAA 1997).

In your case, neither of these exemptions applies to the units you constructed and the house and land are not treated as separate assets by any other provision of the ITAA 1997.

Therefore, under section 109-5 of the ITAA 1997, the acquisition date of your assets for CGT purposes will be the date you acquired the property, notwithstanding that you commenced building the units at a later date.

Sale of the units

CGT event A1 under section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of your interests in each of the subdivided lots.

You will make a capital gain if the capital proceeds from the disposal of each of your interests in each subdivided lot are more than the cost base of the interest. You will make a capital loss if those capital proceeds are less than the reduced cost base of the interest.

Please note, that the original cost of the property, the demolition costs and construction costs of the new units will be included in the cost base for CGT purposes.

Anti-overlap provisions

Section 118-20 of the ITAA 1997 contains anti-overlap provisions which operate to reduce any capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 of the ITAA 1997 as a result of the sale, for example, as ordinary income under section 6-5 of the ITAA 1997.

CGT 50% discount

Where a CGT event A1 occurs, a discount is available on the capital gain where the following conditions in Division 115 of the ITAA 1997 are met:

• the capital gain is made by an individual

• the CGT event occurred after 11.45am on 21 September 1999

• the cost base has not been indexed, and

• the asset must have been acquired at least 12 months before the CGT event.

As you purchased the property several years ago and have met the above conditions, the capital gain is reduced by 50%.

Please note that before you use the 50% discount you first apply any applicable capital losses that you may have to your capital gains.