Edited version of private advice

Authorisation Number: 1051945188735

Date of advice: 21 April 2022

Ruling

Subject: CGT - assessable income

Question

Is the disposal of the Lot 2 property in the 20XX income year subject to capital gains tax (CGT)?

Answer

Yes.

This ruling applies for the following period:

For the income year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The original pre-CGT property was acquired by Person 1 and Person 2 for $x and consisted of land and an old weatherboard dwelling.

In 19XX a unit was constructed on the pre-CGT land and the certificate of occupancy was issued after completion.

The pre-CGT land was later subdivided; and new titles were issued as follows:

Lot 1 - Volume xxxxx Folio xxx is x square metres (front block with the old weatherboard dwelling)

Lot 2 - Volume xxxxx Folio xxx is x square metres (rear, smaller block with the new x bedroom unit)

Lot 3 - Volume xxxxx Folio xxx is x square metres (common property including the driveway).

In 20XX Person 1 and Person 2 changed the legal title of the Lot 2 property by adding their three children for no consideration. This resulted to the property having five owners with equal ownership interest.

Lot 1 remained owned by Person 1 and Person 2 until it was sold in 20XX for $X.

Lot 2 was sold by the owners (Person 1, Person 2, Child 1, Child 2, and Child 3). The sale contract was entered into and settled in the same income year.

The unit contained in Lot 2 has never been used as a main residence for CGT purposes by any of the five owners.

Occupancy of the unit since construction in 1989 has housed short term tenancies such as holiday makers and for approximately x weeks a year, family members on weekend or holiday breaks.

Relevant legislative provisions

Income Tax Assessment Act 1997

Part 3-1

section 6-10

subsection 6-10(4)

section 102-5

section 102-20

section 104-10

section 108-5

section 108-55

subsection 108-55(2)

section 112-20

section 112-25

subsection 112-25(2)

Subdivision 115-A

section 116-30

section 118-10

Reasons for Decision

Summary

The disposal of the Lot 2 property is subject to CGT. The net capital gain will be included in your assessable income for the 20XX income year.

Detailed reasoning

Application of law

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise specified.

Assessable income

Under section 6-10 assessable income includes some amounts that are not ordinary income but are included in your assessable income, by provisions about assessable income, and is called statutory income. If you are an Australian resident for tax purposes, your assessable income includes your statutory income from all sources, whether in or out of Australia (subsection 6-10(4)). Your assessable income includes your net capital gain (if any) under section 102-5.

Section 102-20 states that a capital gain or capital loss is made if and only if a CGT event happens and the gain or loss is made at the time of the event. The most common CGT event is CGT event A1, which occurs when you dispose of a CGT asset. Disposal occurs when a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. The time of the event is when you entered the contract for the disposal, or if there is no contract, when the change of ownership occurs (section 104-10).

Any kind of property such as land and buildings are considered CGT assets (section 108-5). Selling or changing the ownership of real property therefore triggers CGT event A1 and it needs to be determined whether you make a capital gain or capital loss on the transaction by comparing the capital proceeds with your cost base or reduced cost base.

19XX: Building of 2-bedroom unit on pre-CGT land

A building and the land it is on are usually treated as a single asset. However, there are situations where they are treated as separate assets for CGT purposes. Subsection 108-55(2) states that a building or structure that is constructed on land that you acquired before 20 September 1985 is taken to be a separate CGT asset from the land if:

(a)  You entered into a contract for the construction on or after that day; or

(b)   If there is no contract - the construction started on or after that day.

19XX: Subdividing land

The subdivision of the land is not a CGT event if you retain ownership of the subdivided blocks (subsection 112-25(2). Therefore, you do not make a capital gain or a capital loss at the time of the subdivision. However, you may make a capital gain or capital loss when you sell the subdivided blocks. The date you acquired the subdivided blocks is the date you and Jeannette acquired the original parcel of land and the cost base of the original land is divided between the subdivided blocks on a reasonable basis pursuant to section 112-25.

For information on apportionment of cost base, refer to Taxation Determination TD 97/3 Income tax: capital gains: if a parcel of land acquired after 19 September 1985 is subdivided into lots ('blocks'), do Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 treat a disposal of a block of the subdivided land as the disposal of part of an asset (the original land parcel) or the disposal of an asset in its own right (the subdivided block)?

20XX: The effect of transferring to your children - market value substitution rule applies to capital proceeds and children's cost base

If you transfer or gift property to family or friends for no capital proceeds, you are taken to have disposed of the property for its market value at the time of transfer (section 116-30). The transferee is taken to have acquired the property for its market value at the time of the transfer (section 112-20).

The Lot 2 land remains a pre-CGT asset for Person 1 and Person 2 pursuant to subsection 108-55 following the subdivision.

The unit constructed after 20 September 1985 is a separate CGT asset from the land. The cost base for the property is the construction costs you incurred to build the unit.

You may need to get a market valuation from a qualified real estate valuer to determine the value of your capital proceeds for the transfer. The value of your capital proceeds will need to be apportioned equally to your three children who acquired their respective 20% interest in the Lot 2 property. The apportioned amount would be their first element cost base for their respective interest.

Main residence exemption

Generally, an individual can disregard a capital gain or loss from a CGT event that happens to their ownership interest in a dwelling that is their main residence (your home) (section 118-110).

To get the full exemption from CGT:

•         The dwelling must be your main residence for the whole period that you owned it

•         You must not have used the dwelling to produce assessable income, and

•         The land area cannot exceed two hectares.

Discount capital gains

Subdivision 115-A of the ITAA 1997 contains the rules for what is considered a discount capital gain.

Where you held the asset as an Australian resident individual for more than 12 months since the date of acquisition, the capital gain discount percentage you can apply to your capital gain is 50%.

Application to your circumstances

In your case the five owners of the Lot 2 property have never used the unit as a permanent residence. Occupancy since in 1989 has housed short term tenancies such as holiday makers and for approximately x weeks a year, family members on weekend or holiday breaks. An exemption from CGT based on a full or partial main residence exemption therefore does not apply to any of the five property owners.

In 20XX Child 1, Child 2 and Child 3 each acquired an equal ownership interest in the property when you made a change to the legal title of the Lot 2 property.

The effect of the transfer of part of the property into your children's names is relevant as that will determine their date of acquisition and the cost base for the interest, they each acquired in 20XX.

The capital proceeds for the disposal of Lot 2 property would be the consideration received for the disposal; and that amount will be equally apportioned to the five owners having equal interest in the property.

For Person 1 & 2:

•         Each person would get X% of the capital proceeds received from the sale of Lot 2

•         The first element of the cost base would be X% of the construction costs of the unit plus X% of the acquisition cost of the land.

•         Any capital gain or loss made from the disposal that is attributable to the pre-CGT land would be disregarded.

•         Each person only needs to account for the capital gain or loss that is attributable to the unit.

If the capital proceeds are more than the cost base, Persons 1 and 2 will have a capital gain. If the capital proceeds are less than the reduced cost base, they will have a capital loss.

For Child 1, 2 & 3:

•         Their respective interest in the Lot 2 property is a post CGT asset.

•         Each of them would get X% of the capital proceeds received from the sale of Lot 2.

•         Their first element cost base would be X% of the market value of the land and unit or building in 20XX when they acquired their respective interest and became co-owners of the property at that time their names were added in the title of the Lot 2 property.

Where the capital proceeds are more than the cost base, they each will have a capital gain. Where the capital proceeds are less than the reduced cost base, they each will have a capital loss.

The net capital gain will be included in the assessable income of each of the five owners for the 20XX income year.

The steps involved in the calculation of the net capital gain is set out under section 102-5.

Step 1. You may reduce any capital gains by capital losses you made during the income year.

Step 2. Apply any previously unapplied net capital losses from earlier income years to reduce the amounts (if any) remaining after the reduction of capital gains under step 1.

Step 3. Reduce by the discount percentage each amount of a discount capital gain remaining after step 2 (if any).

Step 4. Apply any relevant CGT concessions.

Step 5. Add up the amounts of capital gains (if any) remaining after step 4. The sum is your net capital gain for the income year.

For more information on how to complete the correct question on your tax return go to ato.gov.au and search for Quick Code 'QC 64684' and refer to Income question 18 about Capital gains.