Edited version of your written advice

Authorisation Number: 1012937193218

Date of advice: 20 January 2016

Ruling

Subject:

Capital gains tax - subdivision

Question 1

Will the proceeds from the sale of the dwelling constitute assessable income under section 6-5 of the Income Tax Assessment Act 1997?

Answer

No.

Question 2

Will the capital gains tax (CGT) provisions in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 apply in relation to the sale of unit B?

Answer

Yes.

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.

You are not registered for GST. You bought the property in late 20XX. The property had a house on it which you rented for several months.

You planned to demolish the house and build 2 dwellings. You wanted to build a family home and have an investment property that would help you meet your living expenses in the relevant city. You planned to live in one half of the dwelling (dwelling A) and rent out the other half (dwelling B).

You completed construction in 20YY but the build cost you several hundred thousand dollars more than originally expected. You found a tenant for dwelling B. However, you are experiencing financial difficulties in sustaining loan repayments in view of the cost overrun. You cannot afford to keep dwelling B and are looking to sell that dwelling.

The expenses to demolish the old home and build the dwelling were paid from your joint bank account. The rental income is paid into your joint bank account.

You currently cannot afford to fully complete the subdivision of the property, which is still on one title. If you are able to find a buyer, you then plan to enter into a contract to supply dwelling B subject to a fully completed subdivision and a draft strata plan. Finding a buyer will enable you to raise the funds necessary to create separate titles at the property.

You have never built before. You do not carry on any other enterprise. You have neither bought nor sold other investment properties in the past.

Relevant legislative provision

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 15-15

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 104-10(5)

Income Tax Assessment Act 1997 subsection 115-10

Income Tax Assessment Act 1997 subsection 115-25(1)

Income Tax Assessment Act 1997 subsection 115-100(a)(i)

Reasons for decision

Summary

The proceeds from the sale of the subdivided blocks are not ordinary income and not assessable under sections 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997). The proceeds represent a mere realisation of a capital asset which will fall for consideration under the CGT provisions in Part 3-1 of the ITAA 1997.

Detailed reasoning

Income tax provisions 

As a general principle, profits from property sales will either be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) or statutory income under the capital gains tax (CGT) provisions of the ITAA 1997.

Where the profit has been made as a result of a taxpayer carrying on a business of property development or as a result of a taxpayer entering into an isolated business transaction, the profit will be assessable as ordinary income. However, where the profit is a mere realisation of a capital asset, the profit will be assessable under the CGT provisions of the ITAA 1997.

The first question to address, therefore, is whether you are carrying on a business, and for this, paragraph 13 of Taxation Ruling 97/11 provides the following indicators:

• whether the activity has a significant commercial purpose or character;

• whether the taxpayer has more than just an intention to engage in business;

• whether the taxpayer has a purpose of profit as well as the prospect of profit from the activity;

• whether there is repetition and regularity of the activity;

• whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business; and

• whether the activity is better described as a hobby, a form or recreation or a sporting activity.

Applied to your circumstances, there appears no significant commercial purpose or character to the transaction (i.e. the sale of dwelling B), and you did not have the intention to engage in business. There is neither repetition nor regularity of this type of transaction; in fact, in your circumstances, it appears to be a 'one-off' event. However, it may be the same kind of transaction to that of ordinary trade in that line of business.

Therefore, on balance, our view is that you are not carrying on a business.

However, there is still scope for your transaction to be classed as income gained by a transaction entered into by a non-business taxpayer. Taxation Ruling TR 92/3 considers the assessability of profits on isolated transactions in light of the principles outlined in FC of T v The Myer Emporium (1987) 163 CLR 199. According to Paragraph 1 of TR 92/3, the term 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.

Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction will generally be income within section 6-5 of the ITAA 1997, when both the following elements are present:

• 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 on a business or in carrying out a business operation or commercial transaction.

Some of the factors to consider when looking at whether an isolated transaction amounts to a business operation or commercial transaction are listed at paragraph 13 of TR 92/3. They are: 

(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 or the various steps in the transaction.

If a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

Applying these factors to your circumstances, your current desire to sell dwelling B has been dictated by financial stresses rather than a plan to profit at the time of entering the transaction. You entered into this transaction as individual taxpayers, and not within the structure of a company, and you have not previously entered any transaction of this type. This type of activity, i.e. building dwellings on single residential blocks, is increasingly common for individual owners of residences (as compared to other kinds of property developments). Further, you have managed this project by yourselves as individuals rather than with resort to commercial project management. Finally, that the original residence was rented out for several months, the time span between your purchase and the proposed sale, and your relative inexperience in these kinds of matters, are all indicative of dealings that do not have the nature of a business operation or a commercial transaction.

For these reasons, our view is that this transaction is not entered into with a view to profit or with the characteristics of a commercial operation. Therefore, the proceeds you receive from the development of your property are not ordinary income and not assessable under sections 6-5 of the ITAA 1997. The proceeds represent a mere realisation of a capital asset which will fall for consideration under the CGT provisions in Part 3-1 and 3-3 of the ITAA 1997.

CGT provisions 

CGT event A1 in section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of duplex B.

In your case, you acquired the property in 20XX. Subsection 104-10(4) of the ITAA 1997 provides that a capital gain will arise if the capital proceeds from the disposal are more than the asset's cost base and a capital loss will arise if the capital proceeds are less than the asset's reduced cost base.

Other relevant comments

As you purchased the residential property in 20XX, you have now held it for more than 12 months, and so qualify for a discount on any capital gain made on the sale of dwelling B. The relevant discount for individuals is 50%, pursuant to section 115-100(a)(i).

ATO view documents

Taxation Determination TD 92/124

Taxation Ruling TR 97/11

Taxation Ruling TR 92/3

Other references (non ATO view)

FC of T v The Myer Emporium (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693