Edited version of private advice

Authorisation Number: 1052177074745

Date of advice: 29 November 2023

Ruling

Subject: Property with building defects

Question 1

Will the Commissioner extend the exceptional circumstances exemption relating to vacant land and allow you to continue to deduct rental property expenses for your unit?

Answer

Yes, the Commissioner will extend the exceptional circumstances exemption relating to vacant land and allow you to continue to deduct rental property expenses for your unit.

Question 2

Will the financial assistance amounts, received from a government department be treated as a reduction to the cost base of the unit?

Answer

No, the financial assistance amounts, received from a government department are not treated as a reduction to the cost base of the unit.

Question 3

If the answer to question 2 is no, are the financial assistance amounts received from a government department, treated as assessable income?

Answer

Yes, the financial assistance amounts received from a government department are treated as assessable income.

Question 4

If the answer to question 3 is yes, should the backdated amounts received in the 20XX financial year, relating to various previous tax years, be apportioned and included as assessable income in the relevant years income tax return?

Answer

No, the entire amount of financial assistance is taxable in the financial year in which it is received.

This private ruling applies for the following periods:

1 July 2018 to 30 June 2019

1 July 2019 to 30 June 2020

1 July 2020 to 30 June 2021

1 July 2021 to 30 June 2022

1 July 2022 to 30 June 2023

The scheme commenced on:

1 July 2018

Relevant facts and circumstances

You own unit a property that has known structural defects. You purchased the property in 20XX and it has always been a rental property.

In 20XX, this property was evacuated due to cracking that occurred in the transfer beams.

After the evacuation, the owners corporation undertook extensive research to determine what caused the cracking and determined that it was the fault of the developer of another nearby building. Legal proceedings were commenced against the developer and a settlement was reached however the settlement amount was not enough for the owners corporation to repair the building.

Most recently, the owners corporation have elected to terminate the Strata. Legal proceedings have commenced with a hearing date set for later this year.

Despite the evacuation occurring several years ago, the building is still uninhabitable and cannot be rented out in its current condition.

In the 20XX financial year, you were approved for and received financial support payments from a government department.

The amount received in the 20XX financial year included backdated support payments which related to several previous income tax years.

The support payments from the government department are ongoing. A condition of the financial assistance is that in the event that you receive proceeds from legal proceedings, insurance claim or by settlement agreement, you must reimburse the government department.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Subsection 26-102(6)

Reasons for decision

Question 1

Will the Commissioner extend the exceptional circumstances exemption relating to vacant land and allow you to continue to deduct rental property expenses for your unit?

Summary

The Commissioner will extend the exceptional circumstances exemption relating to vacant land and allow you to continue to deduct rental property expenses for your unit.

Detailed reasoning

Subsection 26-102(1) of the Income Tax Assessment Act 1997 (ITAA 1997) limits the deduction on the amounts relating to holding land if at that time of incurring the loss or outgoing there is no substantial and permanent structure in use or available for use on the land.

This means that from the introduction of the legislation on 1 July 2019 income tax deductions to taxpayers will be denied for losses and outgoings incurred in holding vacant land, regardless of when acquired, to the extent the land is not at the time of incurring the expense or outgoing:

•         used or held available for use by the entity in the course of carrying on a business for the purposes of gaining or producing assessable income; or

•         used or held available for use in carrying on a business by:

o   an affiliate, spouse or child of the taxpayer; or

o   an entity that is connected with the taxpayer or of which the taxpayer is an affiliate

Subsection 26-102(4) of the ITAA 1997 states that residential premises that you construct or substantially renovate will be treated as not being a substantial and permanent structure until they can lawfully be occupied and are leased, hired or licensed (or available for lease, hire or licence).

Subsection 26-102(6) allows an exception where structures have been affected by natural disasters or other exceptional circumstances.

The exemption may apply where an exceptional circumstance outside your control occurs that results in the substantial and permanent structure no longer being on your land or the structure being disregarded. That is, there must have been a substantial and permanent structure on the land prior to the time that the exceptional circumstance occurred. If the substantial and permanent structure was residential premises, then the residence must have been lawfully able to be occupied and have been either leased or available for lease prior to the exceptional circumstance.

Your circumstances are considered to be exceptional circumstances as per section 26-102 of the Income Tax Assessment Act 1997 (ITAA 1997). Therefore, you can deduct the expenses you incurred in holding the vacant land for a period of three years from the date of the exceptional circumstance. Further information about deductions for vacant land can be found by searching 'QC60628' on ato.gov.au

Question 2

Are the financial assistance amounts, received from the government department, treated as a reduction to the cost base of the unit?

Summary

The financial assistance amounts, received from the government department are not treated as a reduction to the cost base of the unit.

Detailed reasoning

The receipt of any compensation takes on the nature of the money it replaces, following the principle in Dixon v FCT. Therefore any compensation that is received by an owner in order to compensate them for their lost rental income, takes on the character of that lost rental income.

The financial assistance amounts received from the government department are not treated as a reduction to the cost base of the unit and are instead considered to be rental or income in nature.

Question 3

If the answer to question 2 is no, are the financial assistance amounts, received from the government department, treated as assessable income?

Summary

The financial assistance amounts received from the government department are treated as assessable income.

Detailed reasoning

The receipt of any bulk compensation takes on the nature of the money it replaces, following the principle in Dixon v FCT. Therefore any compensation that is received by an owner in order to compensate them for their lost rental income, takes on the character of that lost rental income.

Any other payment for pain, loss or suffering is not considered income in nature and is therefore not taxed. If an owner, after receiving an out-of-court settlement that relates to rent, must then pay back monies to the government department, then the money they received from the government department was income that they were previously entitled to but are now no longer entitled to and must be repaid.

Money that must be contractually or legally repaid in a later income year, when an obligation to pay arises, is not considered assessable income as per section 59-30 of the ITAA 1997. This is the case even if no obligation to repay existed at the time the money was derived.

Section 59-30 is designed to cover amounts that are not usually deductible under other deduction provisions, such as section 8-1 (ITAA 97), within tax law. As it is not an amount incurred in producing assessable income but rather an amount where an obligation to repay has arisen at a later date, it is covered by section 59-30 (ITAA 97) and not section 8-1 (ITAA 97). The ATO allows taxpayers to amend previous income tax returns to exclude the amount that must be repaid.

As per section 170(10AA) of the Income Tax Assessment Act 1936 (ITAA 1936), a taxpayer has an unlimited amendment period from when they submit a return to amend it if the amendment is in relation to a payment as covered by section 59-30.

If you do indeed amend your tax return to exclude the rental repayments you would make to the government department, any amounts received from the settlement that replace those repaid amounts will carry with them a rental income nature. Hence they will be assessable when they are derived.

Question 4

If the answer to question 3 is yes, should the backdated amounts received in the 20XX financial year, relating to the period XX 20XX to 30 June 20XX, be apportioned and included as assessable income in the 20XX, 20XX, 20XX and 20XX financial years?

Summary

No, the entire amount of financial assistance is taxable in the financial year in which it is received.

Detailed reasoning

Any amount that is received by an owner in order to compensate them for their lost rental income, takes on the character of that lost rental income. To determine when the amounts must be reported in the relevant income tax return, we must consider when the income is 'derived'. For all matters of the timing of receipts, we must consider when the taxpayer has received or 'derived' the income. TR 98/1 provides further guidance on this issue. Specifically, in paragraph 48 it provides that income associated with rent is 'derived' on a cash basis. That is, the income is derived when you actually receive the money.