Edited version of your written advice

Authorisation Number: 1012927853656

Date of advice: 14 December 2015

Ruling

Subject: Capital gains - Adverse possession

Question 1

For Capital gains tax purpose, does the date of acquisition for a block of land (Property 2) that you gained formal title to under adverse possession laws fall in the 20XX financial year?

Answer

Yes

Question 2

Is the first element of your cost base the market value of the property at the time you gained formal title?

Answer

Yes

Question 3

Will the market value determined above be regarded as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period:

30 June 20

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You leased Property 1 and had the right to use Property 2 effective from the 200X financial year until the 20XX financial year from the previous owners.

Previous owners purchased Property 1 in the 20XX financial year and use of Property 2.

You purchased Property 1 in the 20XX financial year.

The contract of sale for Property 1 stipulated that you also purchased all possessory rights that the previous owners held in respect of the adverse possession.

You gained formal title to Property 2 through the adverse possession claim once the 15 year statutory period had expired in the 20XX financial year.

Relevant legislative provisions

Division 109 of the Income Tax Assessment Act 1997

Subsection 109-5(1) of the Income Tax Assessment Act 1997

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

Section 6-5 of the Income Tax Assessment Act 1997

Section 15-15 of the Income Tax Assessment Act 1997

Reasons for decision

Date of acquisition

Division 109 of the Income Tax Assessment Act 1997 (ITAA 1997) sets out when you are taken to have acquired an asset for CGT purposes. In general, you acquire a CGT asset when you become its owner (subsection 109-5(1) of the ITAA 1997).

In your case you did not become the registered proprietor of the property until the 20XX financial year. However, the law recognises that in special circumstances title to property can be acquired based on a claim of adverse possession.

In order for title to property to be acquired by adverse possession, the person claiming title must establish that the time limit on the right of the registered proprietor to recover possession of the land has expired and that they satisfy the common law requirements of adverse possession.

In your case the property is located in an Australian state. In this state, the relevant limitation period for bringing actions to recover land is 15 years from the date on which the right of action accrued (section 8 of the relevant state act). Once the limitation period has expired, the title of the person entitled to bring an action to recover the land is extinguished (section 18 of the relevant state act.

At common law, to extinguish the registered proprietor's title, the possession must be open, not secret; peaceful, not by force; and adverse, not by the consent of the true owner: Mulcahy v. Curramore Pty Ltd [1974] 2 NSWLR 464 at 475.

In your case, you became the owner of the property in 20XX financial year as you satisfied the common law requirements to establish possessory title and the relevant limitation period expired on this date. Therefore, for the purposes of subsection 109-5(1) of the ITAA 1997 it is considered that you acquired the property in the 20XX financial year.

Market value substitution rule

The market substitution rule comes into effect where an individual does not incur expenditure to acquire a CGT asset (section 112-20 of the ITAA 1997). The market value substitution rule, broadly, is when the cost base is replaced with the market value of the asset.

In your case, you did not incur expenditure to acquire Property 2. The cost base will be the market value of the property during the 20XX financial which was when you obtained ownership of the property.

Ordinary income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that your assessable income includes income according to ordinary concepts.

Section 15-15 of the ITAA 1997 assesses profit arising from the carrying on or carrying out of a profit making undertaking or plan, but does not apply to profits that are assessable as ordinary income under section 6-5 of the ITAA 1997 or that arise in respect of property acquired on or after 20 September 1985.

Profits from isolated transactions will be assessable under section 6-5 of the ITAA 1997 as ordinary income where the intention or purpose 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 out a business operation or commercial transaction (the High Court in Federal Commissioner of Taxation v. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987)18 ATR 693 (Myers case)).

Taxation Ruling TR 92/3 discusses the implications of Myers case. Paragraph 9 of TR 92/3 provides that the requisite intention or purpose to make a profit or gain should usually, but not always, be present at the time the property was acquired.

When you purchased Property 1, the contract of sale stipulated that you also purchased all possessory rights that the previous owners held in respect of the adverse possession of Property 2. There is no profit made on you becoming the owner of the property.

Therefore the market value of Property 2 will not be assessable under section 6-5 of ITAA 1997.