Edited version of private advice

Authorisation Number: 1052023505395

Date of advice: 29 August 2022

Ruling

Subject: CGT - property

Question

Did capital gains tax event A1 occur when you disposed of your ownership interests in Lot 2?

Answer

Yes.

This ruling applies for the following period:

Income year ended 30 June 20XX.

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Your parents, Person A and Person B jointly purchased a property (the Property) prior to 20 September 1985.

Person B passed away after 20 September and the title of the Property was registered in Person A's name as sole proprietor.

You were not able to live independently and had lived at the Property with your parents. You continued to reside at the Property with Person A after Person B passed away, with your sibling, Person C, providing assistance and support for both you and Person A.

Person C was married to Person X and they had a child, Person Y.

Person C passed away several years after Person B had passed away, with Person A (the Deceased) passing away the following year on Date 1.

The Deceased's last Will provided:

•         Person X and Person Y to be appointed at executors of the Will (the Executors) and Trustees of the Deceased's estate (the Trustees); and

•         The Trustees to hold on trust any residuary estate to pay or transfer to you and Person Y in equal shares if you both survived the Deceased by 30 days.

A partition agreement was entered by you and Person Y on Date 2 which is summarised as follows:

•         You and Person Y were both entitled to be registered proprietors of the Property as tenants in common in equal shares

•         You both agreed to partition and subdivide the Property into two lots with the intent that Person Y became the registered owner of Lot 1, being the land at the front of the Property, and you becoming the registered owner of Lot 2, being the land at the rear of the Property

•         You and Person Y would engage a surveyor to prepare a plan of subdivision into two lots, and will do all activities and sign all documents required to have the subdivided certified by the council and approved by the Register of Titles

•         Once the subdivided lots are registered, you and Person Y would do all activities and sign all documents as required to transfer the ownership interest in Lot 1 to Person Y and Lot 2 to you; and

•         The costs incurred in relation to the subdivision, registration of titles, and transferring the ownership of the respective subdivided lots would be paid equally by you and Person Y; and

•         No consideration would be paid to you by Person Y due to the area of Lot 1 being larger than Lot 2.

An agreement was entered into between you and the Trustees on Date 3 under which it was agreed to develop the Property under which the Trustees would:

•         enter into a contract with a builder for the demolition of the existing house on the Property, and the construction of a new house on Lot 1

•         engage a surveyor to prepare a plan of subdivision of the Property into two lots, and undertake all things necessary to have the plan of subdivision certified by Council and approved by the Registrar of Titles

•         transfer to you the ownership of Lot 2 (vacant land) on the new plan of subdivision when and if the subdivision was approved by the Registrar of Titles

•         transfer Lot 1 on the plan of subdivision, upon which the new house would be built, to Person X and Y as tenants in common

Probate was granted on the Deceased's estate some months after the Deceased had passed away.

The title of the Property was transferred to Persons X and Y as joint proprietors in their roles as the Legal Personal Representatives (LPRs) of the Deceased, with the title being registered to reflect the change of ownership.

The title of the Property was transferred from the LPRs to you and Person Y in equal parts as tenants in common, being registered on the Property title.

You resided at the Property for several years after Person A passed away, having lived at the Property for decades, and then moved into supported residential care.

A planning permit application was lodged with the local council (the Council) which was approved by the Council in relation to the development of the Property for two dwellings and the subdivision of the Property into two lots and common property.

The plan of subdivision was lodged with the Land Titles Office, which was approved with Lots 1 and 2 being provided with separate street addresses.

The title of the Property was cancelled due to the subdivision of the Property and the issuing of the titles for Lot 1 and Lot 2.

Following the subdivision, and in accordance with the partition agreement:

•         Person Y's ownership interest in Lot 2 was transferred to you with you becoming the registered sole proprietor of that lot; and

•         You transferred your ownership interest in Lot 1 to Person Y who was registered as the sole proprietor of that lot.

After a significant period of time, a contract for the sale of Lot 2 was entered, with settlement occurring several months later.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-20

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 112-20

Income Tax Assessment Act 1997 Section 112-25

Income Tax Assessment Act 1997 Section 116-20

Income Tax Assessment Act 1997 Section 118-110

Income Tax Assessment Act 1997 Section 118-120

Income Tax Assessment Act 1997 Section 118-130

Income Tax Assessment Act 1997 Section 118-150

Income Tax Assessment Act 1997 Section 118-160

Income Tax Assessment Act 1997 Division 115

Income Tax Assessment Act 1997 Subdivision 118-B

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Capital gains tax

The capital gains tax (CGT) provisions are contained in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997). Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

The CGT provisions apply independently to each CGT asset. The decision about what is a CGT asset is based on history of ownership.

Under subsection 108-5(1) of the ITAA 1997, a CGT asset is:

•         Any kind of property; or

•         A legal or equitable right that is not property.

This includes a part of, or interest in, an asset as outlined above in accordance with subsection 108-5(2) of the ITAA 1997.

The most common CGT event is CGT event A1 occurs when there is a change in legal ownership of a CGT asset under section 104-10 of the ITAA 1997.

Subsection 104-10(3) of the ITAA 1997 provides that the time the CGT event A1 happens is when you enter the contract for the disposal or, if there is no contract, when the change of ownership occurs.

The time when a contract is entered into is the time when it comes into existence for general law purposes.

If a contract is subject to a condition, an issue arises whether the condition is a condition precedent to its formation or whether it is a condition precedent to performance of the contract. In the first case, the contract does not come into existence until the condition is met. In the second case, the condition does not prevent the creation of the contract - non-fulfilment of the condition merely entitles a party to terminate the contract.

You make a capital gain if the capital proceeds from the disposal are more than the CGT asset's cost base. You make a capital loss if the capital proceeds are less than the CGT asset's reduced cost base.

Main residence exemption

The main residence exemption rules contained in Subdivision 118-B of the ITAA 1997 operate a little differently to the basic CGT rules and it is important to understand the difference.

Both look at what is being sold when working out how the CGT provisions will apply when CGT event A1 under section 104-10 of the ITAA 1997 occurs on the disposal of a specific CGT asset. That is, CGT looks backwards at what is being sold and how the CGT asset had been used during your ownership period, and any choices you made in relation to the CGT asset when working out if any exemptions and/or concessions apply.

The focus of the main residence exemption contained in Subdivision 118-B of the ITAA 1997 is the dwelling, and not the land sold with it, described as adjacent land (if less than two hectares).

Generally, any capital gain or capital loss that arises from a CGT event that happens to a dwelling that is a taxpayer's main residence is disregardedunder section 118-110 of the ITAA 1997. However, to be eligible to a full exemption from CGT:

•         the dwelling must have been the taxpayer's main residence for the entire period they owned it (section 118-110 of the ITAA 1997) and must not have been used to produce assessable income (section 118-190 of the ITAA 1997); and

•         the dwelling that was the main residence is being sold, or the main residence exemption is extended to apply to land.

The extension of the main residence exemption to vacant land is limited to the following:

•         To adjacent land up to two hectares when the land is sold with the dwelling that was the main residence under section 118-120 of the ITAA 1997

•         If a dwelling that was your main residence is accidently destroyed, such as by fire, and you dispose of the land on which the dwelling was located on under section 118-160 of the ITAA 1997; or

•         If you build a dwelling on land you already own, the land usually does not start to qualify for the main residence exemption until the dwelling becomes your main residence. You can make a choice under section 118-150 of the ITAA 1997 to enable the land to be viewed as your main residence only when the relevant conditions are met, such as:

-       The newly constructed dwelling becomes your residence as soon as practicable after the dwelling is built, repaired or renovated (paragraph 118-150(3)(a) ITAA 1997), and

-       The newly constructed dwelling continues to be your main residence for at least three months (paragraph 118-150(3)(b) ITAA 1997).

The voluntary demolition of a dwelling is a CGT event C1, which happens if a CGT asset you own is lost or destroyed under subsection 104-20(1) of the ITAA 1997. The main residence exemption will cease if CGT event C1 occurs to the dwelling and none of the provisions to extend the main residence exemption are available on the disposal of vacant land as outlined above.

Subdivision and partitioning of land

Under section 112-25 of the ITAA 1997, the subdivision of land itself does not constitute a CGT event if there is no change of ownership. It is at the time of the disposal that any capital gain or capital loss may arise.

Where a property that was acquired as one asset is subdivided, the new assets are treated as though they were always separate assets. The subdivided blocks will retain the acquisition date of the original property in accordance with the principles contained in Taxation Determination TD 2000/10.

Where land is held by co-owners and they simply wish to subdivide it and retain their respective interests as co-owners in each of the subdivided lots, as outlined above there will be no CGT event and no disposal. It is at the time of the disposal that any capital gain or capital loss may arise, such as the future transfer or disposal of the ownership interest/s in the subdivided lot.

However, if the subdivision is carried out in conjunction with a partition of the property, with the result each of the previous co-owners becomes the sole owner of one or more of the subdivided lots, then there will at the time of partition be:

a)    a CGT event happening in relation to interests of the previous co-owners in each of the subdivided lots that they do not become the sole owners of after the partition; and

b)    acquisitions by each of the previous co-owners who become sole owners of one or more of the subdivided lots of the interests of all other previous co-owners in those subdivided lots.

For CGT purposes, where one co-owner acquires the interest of the other co-owner in land, the taxpayer would have full ownership of the land derived from the acquisition of the two interests, being the co-owner's original ownership interest and the ownership interest acquired from the other co-owner. Taxation Determination TD 2000/31 outlines that the interests remain separate CGT assets for CGT purposes. This means that when a CGT event happens to the two interests, such as a future disposal, there will be a separate date of acquisition and a separate cost base for each interest, and capital proceeds will be determined separately for each interest.

Cost base and reduced cost base of CGT assets

The cost base of a CGT asset includes the cost of the asset when you acquired it, or the ownership interest in a CGT asset, and other costs associated with acquiring, holding and disposing of the asset.

The elements included in the cost base or reduced cost base of a CGT asset are provided in section 110-25 of the ITAA 1997 as follows:

•               The first element of the cost base, being the acquisition costs, is the total of the money paid, or required to be paid, and the market value of the property given, in respect of the acquisition.

•               However, the market value substitution rule will apply under section 112-20 of the ITAA 1997 if you did not deal with the other entity in connection with the acquisition of the asset, with the market value amount being used in the first element of the cost base or reduced cost base.

•               The second element of the cost base are the incidental costs that the taxpayer incurs in acquiring the asset of which relate to a CGT event that happens in relation to the asset. Incidental costs can include stamp duty; remuneration for the services of an accountant, agent, valuer, auctioneer; and the costs of advertising to find a buyer.

•               The third element is the non-capital costs of ownership of an asset. A non-capital cost of ownership of an asset is any expenditure in connection with the continuing ownership of the asset. These costs include interest on money borrowed to acquire an asset, costs of maintaining, repairing and insuring an asset, rates and land tax, interest on money borrowed to refinance the money borrowed to acquire an asset, and interest on any money borrowed to finance capital expenditure incurred to increase an assets value.

•               The fourth element is capital expenditure incurred to increase the value of the CGT asset. This must be reflected in the enhanced value of the asset at the time of the CGT event; and

•               The fifth element is capital expenditure that you incurred to establish, preserve or defend your title to the asset, or a right over the asset.

The reduced cost base of a CGT asset has the same five elements as the cost base, except for the third element.

Application to your situation

Your situation is summarised as follows:

•         Person A passed away on Date 1

•         Under the Deceased's Will, you and Person Y were bequeathed equal shares in the residue of the Deceased Estate, which included equal shares in the Property.

•         The partition agreement was entered into on Date 2 under which you and Person Y agreed that the Property would be subdivided into two lots, and you would each transfer your respective ownership interest in one lot to the other resulting in you each having 100% ownership interest in one of the subdivided lots.

•         The Property was subdivided into two lots, being Lots 1 and 2, and in accordance with the partition agreement:

•         You transferred your ownership interest in Lot 1 to Person Y; and

•         Person Y transferred their ownership interest in Lot 2 to you, with you being registered on the title as the sole proprietor of Lot 2

•         The original house was demolished around the same time and a new house was constructed on Lot 1; and

•         You sold Lot 2, being vacant land.

In this case, a CGT event did not occur when the subdivision of the Property occurred as there was no change in ownership interests in the Property by either you or Person Y. However, for CGT purposes you and Person Y each had equal ownership interests in each of the two subdivided lots.

It is viewed that the partition agreement is a contract and the conditions contained in it indicated the obligations both you and Person Y were required to perform as part of the partition agreement. All the actions following the date the partition agreement was entered into were in relation to you each obtaining the sole ownership in one subdivided lot.

Therefore, CGT event A1 occurred when you and Person Y entered the partition deed on Date 2 to transfer your respective ownership interests, with you disposing of your ownership interest in Lot 1 to Person Y and Person Y transferring their ownership interest in Lot 2 to you.

You held 100% ownership interest in Lot 2 after Person Y transferred their ownership interest in Lot 2 to you, which consisted of several different ownership interests for CGT purposes, with each being a separate CGT asset (as discussed below).

While the transfer of ownership interests under the partition agreement could be viewed as a property for property transfer, for CGT purposes the acquisition amount for the interest you acquired from Person Y will be the market value of that ownership interest as at Date 2 under the market value substitution rules contained in section 112-20 of the ITAA 1997 as you and Person Y had not dealt with each other at arm's length.

Lot 2 was vacant land that was sold. CGT event A1 occurred when Lot 2 was sold, and you disposed of the ownership interests you held in it when the contract of sale was entered.

You did not meet the main residence exemption conditions contained in Subdivision 118-B of the ITAA 1997 as you did not sell the vacant land with a dwelling and/or had not met any of the conditions for the exemption to extend to the vacant land. Therefore, you cannot disregard any capital gain made on the disposal of any of your ownership interests in Lot 2 under any main residence exemption.

A CGT calculation will need to be done in relation to each ownership interest you held in Lot 2 to determine if a capital gain or capital loss was made on the disposal of any of your ownership interests.

For CGT purposes it is viewed that you held the following ownership interests in Lot 2 when it was sold:

§  50% ownership interest inherited from the Deceased. The Deceased held the following two ownership interests in this ownership interest just prior to them passing away:

­   Original X% ownership interest acquired when the Property was acquired prior to 20 September 1985 (pre-CGT).

Your:

•         Acquisition date for this X% ownership interest will be the date the Deceased passed away on Date 1

•         First element of the Cost base or reduced cost base for this ownership interest will include an amount equal to the market value of this X% ownership interest as at the date the Deceased passed away

•         Capital proceeds for the disposal of this ownership interest will be X% of the sale proceeds for Lot 2

­   25% ownership interest inherited by Deceased from Person B, acquired by the Deceased on the date Person B passed away.

Your:

•         Acquisition date for this X% ownership interest will be the date the Deceased passed away, being Date 1

•         First element of the cost base or reduced cost base for this ownership interest will be cost base for the Deceased just prior to them passing away, which will be the market value of the ownership interest on the date Person B passed away

•         Capital proceeds for the disposal of this ownership interest will be X% of the sale proceeds for Lot 2

§  50% ownership interest in Lot 2 transferred to you from Person Y

Your:

-       Acquisition date for this ownership interest will be the date the partition agreement was entered into under section 109-5 of the ITAA 1997, and not when Person Y's ownership interest in Lot 2 was transferred to you

-       The first element in the cost base or reduced cost base for this ownership interest will be the market value of the ownership interest in Lot 2 when the partition agreement was entered, being Date 2, under section 112-20 of the ITAA 1997.

When undertaking the CGT calculations for your ownership interests the following costs should be apportioned on a reasonable basis between the ownership interests:

•         2^nd element of cost base or reduced cost base - costs incurred in relation to the sale of Lot 2; and

•         3^rd element of cost base or reduced cost base - cost incurred in relation to holding costs incurred in relation to Lot 2 taking into consideration your ownership periods for each ownership interest.

Note: When the conditions contained in Division 115 of the ITAA 1997 are met in relation to any of your ownership interests, any capital gain made in relation to that ownership interest can be reduced by the 50% CGT discount.