Edited version of private advice

Authorisation Number: 1051667278289

Date of advice: 21 May 2020

Ruling

Subject: Capital gains tax

Question 1

Is your first element of the cost base of Portion A the Property the Market value in 1991?

Answer

Yes

Question 2

Can you include third element expenses in the cost base of Portion A?

Answer

No

Question 3

Can the Additional Expenses or Dwelling construction costs be included in the fourth element of the cost base of Portion A?

Answer

No

Question 4

Can the capital gains on Portion B be disregarded?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2019

Year ended 30 June 2020

The scheme commences on:

1 July 2018

Relevant facts and circumstances

Person X and their spouse, Person Y, purchased land as Joint Tenants on before 20 September 1985. (the Land).

After 20 September 1985 but before 20 August 1991 the title of the Land was transferred to Person X, Person Y, You and two others as joint tenants.

You did not paid any money or provide any assets in exchange for your joint tenants share.

Your share of the Land is 20% (Portion A).

A few years later Person X and Person Y constructed and paid for a dwelling (the Dwelling) to be built on the Land (the Property) and Person X and Person Y moved in to the Dwelling when it was completed and it was considered their main residence from this time.

You did not incur any costs in the construction of the Dwelling.

You and the two others did not live at the Property at any time.

Person X and Person Y lived in the Dwelling for a number of years until Person X passed away.

The Property was Person X's main residence from when they moved in until they passed away.

Person X's share of the Dwelling and Land was divided between the four remaining joint tenants. You received an additional 5% (Portion B).

Person Y continued to live in the Property, and only recently moved out.

The Property was not used to produce assessable income at any time after Person X's death.

When Person Y moved out they elected to enact the main residence absence rule.

A number of costs (Additional Expenses) were incurred after Person Y moved out and these included general repairs and maintenance expenses, and the addition of a new asset.

The Property was sold.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10

Income Tax Assessment Act 1997 Subsection 104-10

Income Tax Assessment Act 1997 Section 108-7

Income Tax Assessment Act 1997 Section 108-55

Income Tax Assessment Act 1997 Section 108-60

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Subsection 112-20(1)

Income Tax Assessment Act 1997 Subsection 118-145(2)

Income Tax Assessment Act 1997 Section 118-195

Income Tax Assessment Act 1997 Section 128-50

Reasons for decision

Portion A

Question 1

Is your first element of the cost base of Portion A the Property the Market value in 1991?

Answer

Yes. The first element of your cost base of Portion A is the 20% of the value of the Land on March 1991. You did not incur any expenditure to acquire the Land, therefore the market value substitution rule will apply.

Question 2

Can you include third element expenses in the cost base of Portion A?

Answer

No. The third element consists of the costs of owning the CGT asset you incurred (but only if you acquire the asset after 20 August 1991).You acquired the Land prior to that date, further; to qualify for third element costs you must have incurred the cost. You did not incur any costs.

You are not able to apply any third element costs.

Question 3

Can the Additional Expenses or Dwelling construction costs be included in the fourth element of the cost base of Portion A?

Answer

No. Fourth element costs must be capital in nature. Repairs and minor or improvements, are considered not to be capital expenses. Separate depreciable assets are not included in the fourth element. Therefore neither expenses from the Dwelling nor the Additional Expenses can be included in the fourth element of your share (Portion A) of the cost base.

Portion B

Question 4

Can the capital gains on Portion B be disregarded?

Answer

Yes. The CGT can be disregarded on your portion (Portion B) of Person X's share of the Property. Person X had two separate assets the Land and the Dwelling. The Land was purchased prior to 20 September 1985, being an ownership condition on Person X for the main residence exemption to be applied. Just before he passed away the dwelling was considered his main residence and was not being used of the purpose of producing assessable income, which is another ownership condition on Person X for the main residence exemption to be applied.

Person X's Spouse used the property as their main residence until the property was sold, which is a condition for the period after Person X died for the main residence exemption to be applied. Therefore, CGT does not apply to the Dwelling.

Detailed reasoning

Original purchase of Land

Prior to 20 September 1985 Person X and Person Y purchased the Land as joint tenants.

Section 108-7 of the Income Tax Assessment Act 1997 (ITAA1997) provides that individuals who own a Capital Gains Tax (CGT) asset as joint tenants are treated as if they each owned a separate CGT asset constituted by an equal interest in the asset and as if each of them held that interest as a tenant-in-common. Essentially this means that where an asset is owned by persons as joint tenants, CGT will apply as if the one CGT asset was owned by persons as tenants-in-common in equal shares.

In this case Person X owns 50% and Person Y owns 50% of the Land.

The purchase of the land was before 20 September 1985, before the enactment of the Capital Gains Tax legislation.

Transfer of joint tenants to include three others

After 20 September 1985 but before 20 August 1991 the title of the land was transferred to include You and two others in addition to Person X and Person Y as joint tenants.

Person X and Person Y effectively each relinquished 30% of their ownership of the Land to you and the two others, resulting in all five persons now owning a 20% share of the Land.

You did not pay any money or provide any assets for your share of the Land.

At this time a CGT event A1 occurs. CGT event A1 is the disposal of a CGT Asset. As explained in subsection 104-10(2)of the ITAA 1997 you dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law.

For the purposes of CGT Person X and Person Y acquired their share of the Land before 20 September 1985 (Pre CGT) and you acquired your share of the Land on or after 20 September 1985 (Post CGT).

Construction of Dwelling

A few years later Person X and Person Y built a dwelling on the Land. The Dwelling was paid for by Person X and Person Y. You did not provide any funds towards the construction of the Dwelling.

Section 108-55 of the ITAA 1997 outlines the rules when a building is a separate asset from the land. Within it the legislation treats land acquired on or after 20 September 1985 (Post CGT) and land acquired before 20 September 1985 (Post CGT) differently.

In your case section 108-55 of the ITAA 1997 does not apply. Within the legislation it states that a building or structure on land that you acquired on or after 20 September 1985 is taken to be a separate CGT asset from the land if it is either a depreciable asset or R & D activity where a balancing adjustment provision applies. As you acquired your portion of the Land on or after 20 September 1985, and the House is not subject to a depreciable asset or R&D balancing adjustment provision the House and Land are seen as one CGT asset, (The Property).

You own a share of the Property of 20% (Portion A).

For Person X and Person Y, subsection 108-55(2) of the ITAA 1997 applies. In it the legislation explains that a building that is constructed on land that you acquired before 20 September 1985 is taken to be a separate CGT asset from the land if you entered into a contract or started construction on or after that day.

Person X and Person Y started building the Dwelling a number of years after they purchased their share of the Land.

Person X and Person Y essentially have two assets their 20% share of the Land (Pre CGT Asset) and a 20% share of the Dwelling (Post CGT asset).

Main Residence

Person X and Person Y moved into the Dwelling when it was completed.

Person X and Person Y moved into the Dwelling after it was constructed and nominated it to be their main residence.

At no time did you use the Property as your main residence.

The basic concept of the main residence exemption is found at Section 118-195 of the ITAA 1997. The capital gain or loss you make from a CGT event occurring to your swelling is disregarded if the dwelling was you main residence throughout your ownership period.

Person X Passed away

Person X passed away after living in the Dwelling for a number of years. Section 128-50 of the ITAA 1997 contains the rules that apply when a joint tenant dies. In subsection 128-50(2) it says "The survivor is taken to have acquired (on the day the individual died) the individual's interest in the asset. If there are 2 or more survivors, they are taken to have acquired that interest in equal shares."

Therefore the share of both the Dwelling and Land owned by Person X at their death is divided equally amongst the remaining four joint tenants (Person Y, you and two others). This equates to two additional CGT Assets for each person 5% of the Dwelling and 5% of the Land (Portion B).

Person Y moves out and Sale of the Property

Person Y moved out of the Dwelling.

Subsection 118-145(2) of the ITAA 1997 says that once a dwelling has qualified as the taxpayer's main residence it can continue to be treated as such during a subsequent period of absence. You are not required to re-occupy the dwelling before a CGT event happens to it in order to be able to apply the exemption.

Where the dwelling deemed to be the main residence is sold generally it will be the date that legal ownership ceases (settlement) that is relevant rather than the contract date.

The Property was sold and settlement occurred.

You make a capital gain or loss when a CGT event occurs. The sale of a property gives rise to a CGT event A1 disposal of a CGT Asset. The Timing of the event is when the disposal contract is entered into. You make a capital gain if the capital proceeds from the disposal are more than the assets cost base. A capital loss occurs when the assets reduced cost base is more than the capital proceeds.

Cost base

The cost base if a CGT asset contains five elements. The general rules are found in section 110-25 of the ITAA 1997.

The first element is the money you paid, or are required to pay, in respect of acquiring the asset and the market value of any other property you gave or required to give in respect of acquiring the asset.

The second element is the incidental costs you incurred.

The third element is the costs of owning the CGT asset you incurred (but only if you acquire the asset after 20 August 1991)

The fourth element is capital expenditure you incurred to increase or preserve the assets value.

The fifth element is capital expenditure you incurred to establish preserve or defend you title to the asset.

Separate CGT Assets

Additional expenses were incurred after Person Y moved out.

Items that are sold within a property that are separate CGT assets are not part of the real property and not included in the cost base.

Section 108-60 of the ITAA 1997 provides that a depreciating asset that is part of a building or structure is taken to be a separate CGT asset from the building or structure.

Further, Taxation Determination TD 98/24 Income tax: capital gains: what are the CGT consequences of a CGT event happening to post-CGT real property if the property comprises separate CGT assets under Subdivision 108-D in Part 3-1 of the Income Tax Assessment Act 1997 (the 1997 Act) or if the property is sold with depreciable assets?, cements the Commissioners view. It says that chattels (e.g., items of furniture) that are sold with the property are separate CGT assets in their own right and are not part of the real property. This is the case whether the chattels were acquired with the property or afterwards.

Portion A

Question 1

Is your first element of the cost base of Portion A the Property the Market value in 1991?

The first element of the Cost base is the money you paid to acquire your share of the Property (Portion A). You did not incur any money for your share of joint tenant ownership of the Land in 1991.

In some cases you can use the Market value substitution rules found in subsection 112-20(1) of ITAA 1997. The legislation explains that

The first element of your cost base of a CGT asset you acquire from another entity is its market value (at the time of acquisition) if:

(a) you did not incur expenditure to acquire it, except where your acquisition of the asset resulted from:

(i) *CGT event D1 happening; or

(ii) another entity doing something that did not constitute a CGT event happening; or

(b) some or all of the expenditure you incurred to acquire it cannot be valued; or

(c) you did not deal at arm ' s length with the other entity in connection with the acquisition.

As you did not incur any expenditure to acquire the Land the market value substitution will apply.

The first element of your cost base of Portion A is the 20% of the value of the Land in 1991.

Question 2

Can you include third element expenses in the cost base of Portion A?

The third element rules are found in section 110-25 of the ITAA 1997. It states that the third element consists of the costs of owning the CGT asset you incurred (but only if you acquire the asset after 20 August 1991).

You acquired the Land in after 20 September 1986 but before 20 August 1991. Further, to qualify for third element costs you must have incurred the cost. You did not incur any costs.

Therefore, you have no third element considerations in your cost base.

Question 3

Can the Additional Expenses or Dwelling construction costs be included in the fourth element of the cost base of Portion A?

The fourth element of the cost base of a CGT asset according to subsection 110-25(5) of the ITAA is capital expenditure the taxpayer incurred:

· for the purpose or the expected effect of which is to increase or preserve the asset ' s value, or

· that relates to installing or moving the asset

For expenditure to fall within the fourth element, the expenditure must be of a "capital nature ". Where there is doubt or uncertainty, the authorities on the meaning of "expenditure of a capital nature" in the general deduction provision and the general principles derived from those authorities are relevant.

Recurrent expenditures, such as rates and taxes relating to land and repairs to premises, would not fall within this cost base element, since they are generally not of a capital nature.

Taxation Ruling TR 97/23 Income tax: deduction for repairs, considers where repairs may be of a capital nature, and the distinction between a repair and an improvement. It says that a 'repair' for the purposes of section 25-10 of the ITAA 1997 (that are not capital expenditure) is a question of fact and degree in each case having regard to the appearance, form, state and condition of the particular property at the time the expenditure is incurred and to the nature and extent of the work done to the property.

Repairs that amounts to substantial improvements, additions or alterations, are considered to be capital in nature however, minor and incidental improvements, additions or alterations are considered not to be capital expenses.

Generally non-capital expenditures do not satisfy either the increase in value test or are reflected in the value of the asset at the time of the CGT event.

For an improvement to be considered capital, the items condition or value is enhanced beyond its original state at the time of purchase.

Generally, when you build a dwelling on land after the purchase of the land any costs you incurred would be included in the fourth element.

Dwelling

You have said that Person X and Person Y paid for the construction of the Dwelling. You did not pay for or contribute to the funds for building the dwelling. Therefore, you did not incur any expenditure.

You do not have any dwelling expenses included in the fourth element considerations.

Additional Expenses

You have provided a number of invoices (Additional Expenses) with details of general repairs and maintenance expenses. These costs are not capital in nature, they are general deductions and do not form part of the fourth cost base.

New Assets

Included in the Additional Expenses is the cost for a new asset included in the Dwelling.

Section 108-60 of the ITAA 1997 provides that a depreciating asset that is part of a building or structure is taken to be a separate CGT asset from the building or structure. For example integral parts of the building (carpets, window dressings etc.) which are treated as assets for depreciation purposes will be treated as separate assets.

The asset is considered a separate asset, and as such not included in the considerations of the fourth element of the cost base.

Conclusion

Neither the Additional expenses from the Dwelling nor from Additional Expenses can be included in your share (Portion A) of the fourth element of the Property's cost base.

Portion B

Question 4

Can the capital gains on Portion B be disregarded?

Person X had two separate assets the Land and the Dwelling.

The Land was purchased prior to 20 September 1985.

Just before they passed away the dwelling was considered their main residence.

We look to Section 118-195 of the ITAA 1997 "Dwellings acquired from deceased estates" to provide the rules regarding exemptions from CGT.

Subsection 118-195(1) states that

A capital gain or capital loss you make from a CGT event that happens in relation to a dwelling or your ownership interest in it is disregarded if:

(a) you are an individual and the interest passed to you as a beneficiary in a deceased estate, or you owned it as the trustee of a deceased estate; and

(b) at least one of the items in column 2 and at least one of the items in column 3 of the table are satisfied; and

In this case the deceased acquired the ownership of the Land before 20 September 1985 and the Dwelling after 20 September 1985, and the dwelling was the deceased's main residence just before his death and was not being used of the purpose of producing assessable income.

Therefore, CGT does not apply to the dwelling as it continued to be the main residence of Person Y who was the spouse of the Person X immediately before the deceased's death.

Person Y vacated the property. As a general rule, a dwelling ceases being your main residence once you stop living in it. However, Person Y chose to continue to use this dwelling as their main residence for capital gains tax purposes.

As the property was Person Y's Main residence and they used it as their main residence until the property was sold the CGT does not apply to Person X's share of the Dwelling.

The CGT can be disregarded on your portion (Portion B) of Person X's share of the Property.