Edited version of private advice

Authorisation Number: 1052062777104

Date of advice: 25 November 2022

Ruling

Subject: CGT - special rule for first use to produce income

Question 1

Did you acquire the property for its market value in accordance with subsection 118-192(2) of the Income Tax Assessment Act 1997?

Answer 1

Yes

Question 2

Can you include second element costs in the cost base of the Property?

Answer 2

No

Question 3

Can you include third element costs in the cost base of the Property?

Answer 3

No

Question 4

Can you include fourth element costs in the cost base of the Property?

Answer 4

No

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You purchased a block of land (the Property) in XXXX. The block of land was under 2 hectares

You purchased the Property as joint owners.

You built a dwelling on the Property and moved in as soon as construction was complete on XXXX

You moved out of the dwelling on XXXX and commenced renting it out.

For the period you rented out the Property, you didn't have an ownership interest in any other dwelling.

You will not exercise the absence choice in section 118-145 of the Income Tax Assessment Act 1997 when calculating your eligibility for a main residence exemption on disposal of the Property, as you had purchased another property which you choose to treat as your main residence

You incurred costs in relation to acquiring the Property.

You incurred costs in relation to ownership of the Property.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 118-145

Income Tax Assessment Act 1997 section 118-192

Reasons for decision

Question 1

Summary

You meet the requirements in subsection 118-192(2) of the Income Tax Assessment Act 1997 (ITAA 1997). You are therefore taken to have acquired the Property for its market value on XXXX.

Detailed reasoning

The cost base of a capital gains tax (CGT) asset consists of five elements. The first element of the cost base is generally the cost of the asset when you buy it. However, this element can be modified in certain circumstances. One of these circumstances is where the CGT asset is your main residence, and you start to use it to produce income for the first time after 20 August 1996.

If you start using your main residence to produce income for the first time after 20 August 1996, a special rule in section 118-192 of the ITAA 1997 affects the way you calculate your capital gain or capital loss from a capital gains tax (CGT) event that happens in relation to that main residence.

This rule (under subsection 118-192(2) of the ITAA 1997) provides that you are taken to have acquired the dwelling at its market value at the time it was first used to produce income if all of the following conditions apply:

•                     you acquired the dwelling on or after 20 September 1985;

•                     you first used the dwelling to produce income after 20 August 1997;

•                     when a CGT event happens in relation to the dwelling, you would only get a partial exemption because the dwelling was used to produce income during the period you owned it (your ownership period); and

•                     you would have been entitled to a full exemption if the CGT event happened to the dwelling immediately before you first used it to produce income.

Where these conditions are satisfied, you do not have to keep records of expenditure on a dwelling which is solely a main residence until the time when it is first used for income-producing purposes.

Application to your circumstances

You meet the requirements in subsection 118-192(2) of the Income Tax Assessment Act 1997 (ITAA 1997). You are therefore taken to have acquired the Property for its market value on XXXX.

Question 2, 3 and 4

Summary

When using the first used to produce income rule, as per section 118-192 of the Income Tax Assessment Act 1997 (ITAA 1997). any expenditure incurred prior to the first income use date is ignored. You are therefore not able to add any second, third or fourth element costs you incurred prior to the first income used date in the cost base of the Property.

Detailed reasoning

As previously mentioned, under section 118-192 of the Income Tax Assessment Act 1997 (ITAA 1997), if you start using your main residence to produce income, the first used to produce income rule affects the way you calculate your capital gain or capital loss. In working out the amount of capital gain or capital loss, the period before the dwelling is first used to produce income is not considered.

You are taken to have acquired property at the time it was first used to produce assessable income, and the first element of the cost base is its market value on that day. Additionally, any expenditure incurred by you prior to that day are ignored.

This is supported within ATO Interpretative Decision ATO ID 2003/1112 Income Tax Capital gains tax: main residence exemption - dwelling first used to produce income, which states that the dwelling's cost base and reduced cost base is the market value of the dwelling on the day it was first used for income producing purposes (and that expenditure incurred by the taxpayer prior to that day is ignored). Although ATO ID 2003/1112 has been withdrawn, it remains technically correct.

You are therefore unable to include any second, third or fourth element costs you incurred prior to the first income use date in the cost base.