Edited version of your written advice

Authorisation Number: 1012963111826

Date of advice: 9 February 2016

Ruling

Subject: CGT implications on sale of property

Question 1

Does the sale of a subdivided property ('the subdivided property') constitute a 'mere realisation' of the subdivided property, assessable on capital account and dealt with exclusively under Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is any net profit derived from the sale of the subdivided property assessable as ordinary income under section 6-5 of the ITAA 1997?

Answer

No. The profit is on capital account.

Question 3

If the sale of the subdivided property is on capital account, does the cost base of the subdivided property include its market value as at the first time the original land parcel ('the property') was rented, in accordance with section 118-192 of the ITAA 1997, or does the cost base of the subdivided property include an apportioned amount of the cost base of the property, in accordance with section 112-25 of the ITAA 1997?

Answer

The cost base of the subdivided property includes an apportioned amount of the cost base of the property at the time of the subdivision.

Question 4

If the sale of the subdivided property is on capital account, can the taxpayer (having never claimed the main residence exemption on any property previously) rely on the temporary absence rule under section 118-145 of the ITAA 1997?

Answer

No.

Question 5

If the sale of the subdivided property is on revenue account, does the cost of the subdivided property include its market value at the time of the subdivision?

Answer

This question is not applicable as the sale of the subdivided property is on capital account. See response to questions 1 and 2.

This ruling applies for the following periods:

Year ended 30 June 20XX

The scheme commences on:

01 July 20XX

Relevant facts and circumstances

The taxpayer ('you') entered a contract for the purchase of the property.

You resided in the property until you were required to relocate for work purposes. At this point you rented the property for the first time.

You did not sell the property as you held the view you may return to it at some point. Further, you accepted the property was in a good location and speculated on its capital growth.

The property was rented out for a number of years. At this point, the property was demolished and green titles were created between neighbouring properties.

Your intention at the time of purchase was to live in the property. This intention changed when the property was subdivided and your intention became one of profit-making.

You incurred various costs for the subdivision in respect of both subdivided properties. These costs related to demolition costs, council and consultant fees, retaining, the connection of electricity, plumbing, fencing, security, paving and reticulation.

You did not receive any proceeds for the demolition of the dwelling on the property.

You constructed a new dwelling on the subdivided property at your own cost.

When the subdivision and construction of the new units was completed, the units were then rented.

You did not have a business plan as such but an informal plan to hold the subdivided properties for some years and then sell them when you approached retirement.

You have not subdivided and sold any other properties.

You are not in the business of property development, but rather have an interest in property.

You were involved in organising site works, contractors, council approval, etc.

The subdivided property was sold with a real estate agent at a profit to you.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Part 3-1.

Income Tax Assessment Act 1997 Section 104-20.

Income Tax Assessment Act 1997 Paragraph 104-20(2)(b).

Income Tax Assessment Act 1997 Subsection 104-20(3).

Income Tax Assessment Act 1997 Paragraph 108-5(2)(a).

Income Tax Assessment Act 1997 Section 112-25.

Income Tax Assessment Act 1997 Subsection 112-25(2).

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

Income Tax Assessment Act 1997 Section 112-30.

Income Tax Assessment Act 1997 Subsection 112-30(2).

Income Tax Assessment Act 1997 Subsection 112-30(3).

Income Tax Assessment Act 1997 Subsection 112-30(4).

Income Tax Assessment Act 1997 Subdivision 118-B.

Income Tax Assessment Act 1997 Section 118-110.

Income Tax Assessment Act 1997 Paragraph 118-110(2)(a).

Income Tax Assessment Act 1997 Subsection 118-115(1).

Income Tax Assessment Act 1997 Paragraph 118-115(1)(a).

Income Tax Assessment Act 1997 Section 118-125.

Income Tax Assessment Act 1997 Section 118-145.

Income Tax Assessment Act 1997 Section 118-150.

Income Tax Assessment Act 1997 Subsection 118-150(3).

Income Tax Assessment Act 1997 Section 118-192.

Income Tax Assessment Act 1997 Subsection 118-192(2).

Further issues for you to consider

Consequences upon demolition of dwelling

Section 104-20 of the ITAA 1997 provides that CGT event C1 happens if a CGT asset you own is lost or destroyed. As a CGT asset includes part of an asset pursuant to paragraph 108-5(2)(a) of the ITAA 1997, CGT event C1 can apply to part of a CGT asset.

Taxation Determination TD 1999/79 confirms that CGT event C1 can happen on the voluntary destruction of an asset, such as where a taxpayer demolishes a building in the course of redeveloping a property. The demolition of your dwelling on the property therefore falls within the concept of 'destruction' for the purpose of CGT event C1.

As you received no compensation for the destruction of the asset, this CGT event C1 happened when the destruction occurred (paragraph 104-20(2)(b) of the ITAA 1997).

Generally, where a CGT event happens to only part of the land parcel (i.e. the dwelling), the cost base between the land and the demolished dwelling is apportioned pursuant to subsection 112-30(2) of the ITAA 1997 in accordance with the rules in subsections 112-30(3) and (4) of the ITAA 1997.

However, as you received no capital proceeds from the demolition of the dwelling, the combined effect of these provisions is that no amount is apportioned to the cost base or reduced cost base of the demolished dwelling.

As both the cost base and capital proceeds in respect of the demolished dwelling is nil, you did not make a capital gain or capital loss under subsection 104-20(3) of the ITAA 1997 due to the demolition of your dwelling on the property.

Reasons for decision

Questions 1 and 2 are considered together

Summary

The sale of the subdivided property constitutes a 'mere realisation' of the subdivided property and is on capital account dealt with exclusively under the CGT provisions. As such, no net profit derived by you will be assessable as ordinary income under section 6-5 of the ITAA 1997.

Detailed reasoning

Taxation Ruling TR 92/3 sets out the Commissioner's view on the tax treatment of profits on isolated transactions. It provides (at paragraph 6) that a profit from an isolated transaction is generally income when both of the following elements are present:

• the intention or purpose of the taxpayer 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.

On the point of isolated transactions, the Full High Court in FC of T v The Myer Emporium Ltd (1987) 163 CLR 213 explained:

"It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realisation. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction"

Furthermore, the courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. The expression "mere realisation" is used to contradistinguish a business operation or commercial transaction carrying out a profit-making scheme (TR 92/3, paragraph 36).

Therefore, the taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If the 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. Such a profit-making purpose is to be discerned from an objective consideration of the facts and circumstances of the relevant case.

You purchased the property as your main residence and lived in it for a number of years. You were required to relocate for work purposes at which time you rented the property out. You chose not to sell the property as you anticipated returning to it in the future.

On the basis of these facts and circumstances, you did not purchase the property with the intention at the time of acquisition for the purpose of profit-making by sale, such that any profit derived from its sale (as part of an isolated transaction) will not be assessable on revenue account.

The sale of the subdivided property constitutes a mere realisation of a CGT asset (even though that realisation occurred in an enterprising way), and any profit made is assessable on capital account.

In conclusion, the profit you made is capital in nature and subject to Part 3-1 of the ITAA 1997. It is not considered ordinary income assessable under section 6-5 of the ITAA 1997.

Question 3

Summary

The cost base of the subdivided property includes an apportioned amount of the cost base of the property at the time of the subdivision as per section 112-25 of the ITAA 1997.

Detailed reasoning

Whilst the splitting of an original land parcel into two or more blocks does not of itself result in a CGT event happening (as per subsection 112-25(2) of the ITAA 1997), Taxation Determination TD 97/3 confirms (at paragraph 2) that the subdivided blocks are treated as separate assets under the capital gains provisions, taken to have been acquired by the owner of the original land parcel when that parcel was acquired.

It follows, where both the original land parcel and each of the new blocks are beneficially owned by the same taxpayer, and in accordance with the method statement set out in subsection 112-25(3) of the ITAA 1997, that each element of the cost base and reduced cost base of the original land parcel (worked out at the time of the split) is apportioned in a reasonable way and included in the corresponding element of the cost base and reduced cost base of each new block (TD 97/3, paragraph 4).

For the purposes of working out the cost base and reduced cost base of the original land parcel at the time of the split in circumstances where a dwelling on that land parcel is voluntarily destroyed and no proceeds are received in respect of that destruction, by virtue of the operation of section 112-30 of the ITAA 1997 the original cost base or reduced cost base of both the land and dwelling is wholly attributable to the land.

In determining the extent to which it is reasonable to attribute each element of the cost base and reduced cost base of the original land parcel to the corresponding element of the cost base or reduced cost base of each new block, the note after paragraph 5 of TD 97/3 confirms that the Commissioner will accept any approach that is appropriate in the circumstances of the particular case. TD 97/3 proceeds to explain that a reasonable apportionment of the cost of land can usually be achieved on an area basis if all the land is of similar market value or, if that is not the case, on a relative market value basis.

In accordance with the above, the cost base of the subdivided property (a CGT asset in its own right) includes a reasonably apportioned amount of the cost base of the property as at the time of the subdivision. The cost base of the property as at the time of the subdivision includes the original cost base of the property which, in turn, includes the original cost of the part of the property (i.e. the dwelling) since demolished.

The special rule under subsection 118-192(2) of the ITAA 1997 relating to dwellings in respect of which a partial main residence exemption applies does not apply to the subdivided property as (for reasons set out below in response to question 4) the subdivided property is not a dwelling in respect of which a partial main residence exemption applies.

Question 4

Summary

You cannot rely on the temporary absence rule under section 118-145 as the main residence exemption does not apply to disregard the capital gain made upon the disposal of the subdivided property.

Detailed reasoning

Subdivision 118-B of the ITAA 1997 sets out the rules for the main residence exemption under which the whole or part of a capital gain or capital loss made from a CGT event that happens in relation to a dwelling or an individual taxpayer's ownership interest in it may be disregarded. The availability of the exemption is subject to a range of conditions.

The main condition that underlies the operation of this exemption is that a dwelling qualifies as the individual taxpayer's "main residence" throughout their period of ownership and it has not been used to produce assessable income during that period. To the extent that it has been used to produce assessable income, only a partial exemption, may apply.

In addition, a range of other 'basic' conditions must be met for the exemption to be available in full or part.

Importantly, Subdivision 118-B of the ITAA 1997 contains a range of rules that permit a dwelling to be treated (or continue to be treated) as the taxpayer's main residence in circumstances where the dwelling would otherwise not qualify as a main residence, such as during an absence.

Main Conditions

Section 118-110 of the ITAA 1997 sets out the 'basic' situation in which a capital gain or capital loss made from a CGT event that happens to a dwelling, or a taxpayer's ownership interest in it, will be disregarded. Essentially, the capital gain or capital loss will be fully exempt only where:

• the entity involved is an individual

• the dwelling was the individual's main residence throughout their ownership period

• the individual did not acquire the ownership interest either as a beneficiary or trustee of a deceased estate, and

• the CGT event is a relevant CGT event.

Individual taxpayer (other than beneficiary or trustee)

You are an individual taxpayer whose interest in the relevant dwelling was not acquired as a beneficiary or trustee of a deceased estate, thereby satisfying the first and third of the main conditions.

Relevant CGT event

Paragraph 118-110(2)(a) of the ITAA 1997 lists a number of 'relevant' CGT events to which the main residence exemption will apply.

The disposal of the subdivided property gave rise to a CGT event A1. The main residence exemption can apply to disregard a capital gain or loss made from a CGT event A1. The fourth of the main conditions has therefore been satisfied.

Was the dwelling on the subdivided property your main residence? (second main condition)

Dwelling

Dwelling is defined in subsection 118-115(1) of the ITAA 1997 to include:

a) a unit of accommodation that is a building or is contained in a building and which consists wholly or mainly of residential accommodation

b) a unit of accommodation that is a caravan, houseboat or other mobile home, and

c) any land immediately under the unit of accommodation.

The unit on the subdivided property is a dwelling pursuant to paragraph 118-115(1)(a) of the ITAA 1997.

Ownership period

"Ownership period" is defined in section 118-125 of the ITAA 1997 to mean the period on or after 20 September 1985 when a taxpayer had an ownership interest in either:

(a) the dwelling, or

(b) land (acquired on or after 20 September 1985) on which the dwelling is later built.

You had an ownership interest in land on which the relevant dwelling was later built. Your ownership period of that dwelling is therefore taken to have begun when that land was purchased, and ended on the date the dwelling was disposed of.

Main residence

Ordinarily where a dwelling is demolished or destroyed and a new dwelling is constructed, the main residence usage of the first dwelling would not count towards an exemption of a capital gain or loss made from the happening of a relevant CGT event in relation to the new dwelling.

Whilst a taxpayer may, pursuant to section 118-150 of the ITAA 1997, make a choice under certain circumstances to treat a newly built dwelling as the taxpayer's main residence from the time that they acquired an ownership interest in the land on which it is built, that choice can only be made if the newly built dwelling becomes that taxpayer's main residence as soon as practicable after the building work is finished and it continues to be their main residence for a minimum of three months (subsection 118-150(3) of the ITAA 1997).

On the basis of the above, the main residence exemption is not available to you in respect of the capital gain that you made from the disposal of the subdivided property because the newly built dwelling on it was not your main residence at any stage during your ownership period (and the second of the main conditions under section 118-110 of the ITAA 1997 has not been satisfied).

The effect of section 118-145 of the ITAA 1997 is to continue to treat a dwelling that has qualified as the taxpayer's main residence as their main residence during a subsequent period of absence. Given the dwelling on the subdivided property was never your main residence the application of section 118-145 of the ITAA 1997 is of no relevance and cannot be relied on.