Edited version of private advice

Authorisation Number: 1051985044416

Date of advice: 28 July 2022

Ruling

Subject: CGT - first element - market value substitution rule

Question

Is the first element of the cost base of the property (Property A) the market value at the time you acquired Property A?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

In 19XX, your parent purchased a property (Property A).

At the time, Property A had a single dwelling on it.

Ten years later, your parent transferred ownership of Property A to you for no consideration.

Following acquisition of Property A, you resided in the dwelling on Property A for several years.

After that time, the dwelling on Property A was used to produce rental income. It was also occasionally used to provide accommodation to your relatives. You did not charge your relatives rent to stay in the dwelling at Property A.

In 20XX, you demolished the existing dwelling on Property A and subdivided the land into two lots.

The subdivided lots are Property B and Property C.

You then built one unit on Property B and one unit on Property C.

The two units were sold the following year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 paragraph 112-20 (1) (c)

Reasons for decision

Summary

Subsection 112-20(1) of the ITAA 1997 will apply to substitute the market value of Property A at the time of acquisition as the first element of the cost base.

Detailed reasoning

Relevant law

Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a capital gain or capital loss results from a capital gains tax (CGT) event occurring.

Subsection 104-10(1) of the ITAA 1997 provides that CGT event A1 happens if an entity disposes of a CGT asset. A 'disposal', as defined in subsection 104-10(2) of the ITAA 1997, occurs when there is a change of ownership from one entity to another. A 'CGT asset', as provided in section 108-5 of the ITAA 1997, is:

•         any kind of property, or

•         a legal or equitable right that is not property.

CGT event A1 will be triggered when an entity sells a property. The capital gain from such an event is the difference between the capital proceeds and the cost base of the relevant CGT asset.

General rules about cost base are provided in section 110-25 of the ITAA 1997. Subsection 110-25(1) of the ITAA 1997 states that the cost base of a CGT asset is made up of five elements.

Subsection 110-25(2) of the ITAA 1997 provides that:

The first element is the total of:

(a)the money you paid, or are required to pay, in respect of acquiring it; and

(b)the market value of any other property you gave, or are required to give, in respect of acquiring the asset

The market value substitution rule

There are a number of modifications to the general rules about cost base. The market value substitution rule in section 112-20 of the ITAA 1997 modifies the general rule by replacing the first element of the cost base and reduced cost base of a CGT asset acquired from another entity with its market value (at the time of acquisition) where:

(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

Application to your circumstances

As you acquired Property A from your parent for no consideration, the market value substitution rule will apply to modify the first element of the cost base of Property A. The first element of the cost base will be the market value of Property A at the time of acquisition from your parent.

As Property A has been subdivided into two lots, you will be required to apportion the cost base across Property B and Property C on a reasonable basis.