Edited version of private advice

Authorisation Number: 1052396035808

Date of advice: 19 June 2025

Ruling

Subject: Income vs capital

Question 1

Will the profit from the sale of the proposed two townhouses be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), on revenue account, as a result of carrying on a business of property development?

Answer

No.

Question 2

Will the profit from the sale of the proposed two townhouses be assessable as ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of entering into a profit-making undertaking or isolated transaction?

Answer

Yes.

Question 3

Would any applicable capital gain be reduced by any amount assessable as ordinary income?

Answer

Yes.

This ruling applies for the following periods:

Year ending XX XXX 20XX

The scheme commenced on:

XX XXX 20XX.

Relevant facts and circumstances

The property is located at Address A.

In 19XX you and your spouse (hereinafter collectively referred to as 'you') purchased the property for $X.

In 19XX you demolished the existing dwelling on the property and built a new dwelling for approximately $X.

You have lived in the property as your main residence since XXX 19XX.

The dwelling now requires significant maintenance.

You have explored various options for downsizing but settled on the option of building four townhouses on site.

In XXX 20XX you obtained a notice of decision from Council A with respect to a planning application.

Your intention is to demolish the current dwelling on the site and build four townhouses. You will use one as your main residence, maintain ownership of another and use this for rental income, and sell the remaining two townhouses, one on completion of the build and one will be leased for 12 months and then sold.

The estimated construction cost for the development is approximately $X dollars.

You intend to finance the construction of the townhouses with a $X dollar construction loan.

The sale of the two townhouses will fund the repayment of the construction loan and cover taxes.

This is a one time development of your property and current main residence.

You do not have a history of any large-scale property development.

You are retirees who did not previously work in the building and construction sector.

You are using a third party builder and project manager to handle the development.

The property has never been used for business or commercial purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 118-20

Reasons for decision

Issue Income or capital

Summary

It is the Commissioner's opinion that you are not in the business of property development. However, the proposed scheme of demolishing the existing dwelling, subdividing the property, building the four townhouses and selling two of them, is considered to be in the nature of an isolated commercial transaction undertaken for the purpose of making a profit. As such the profit from the sale of the two townhouses will be assessable as ordinary income under section 6-5 of the ITAA 1997.

While CGT event A1 will happen upon the sale of each of the two townhouses, any capital gain made on their disposals will be reduced to the extent that the profit from the sales is already included in your assessable income.

Detailed reasoning

In broad terms, there are three ways profits from the subdivision and sale of property can be treated for taxation purposes:

   1. as ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of carrying on a business of property development

   2. as ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated business or commercial transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business, where the land was acquired or subsequently held for profit making purpose and/or

   3. as statutory income under the CGT legislation on the basis that a realisation of a capital asset has occurred.

Carrying on a business of property development

Section 995-1 of the ITAA 1997 defines what activities may be included in a business. It is not a source of guidance for determining whether the nature, extent, and manner of undertaking those activities amount to carrying on of a business.

Taxation ruling TR 97/11 Income Tax: am I carrying on a business of primary production? provides guidance towards those aspects that are seen to be relevant as indicators that an individual is carrying on a business. The relevant indicators are:

   • whether the taxpayer has more than just an intention to engage in business

   • whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

   • whether there is repetition and regularity of the activity

   • whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business

   • whether the activity is planned, organised, and carried on in a businesslike manner such that it is directed at making a profit

   • the size, scale and permanency of the activity, and

   • whether the activity has a significant commercial purpose or character (this indicator comprises many aspects of the other indicators).

No one point above is a clear indicator of whether a taxpayer is carrying on a business. It is more a question of fact and degree.

Application to your circumstances

In your case, you are not, nor have you ever been, in the business of property development. The proposed development is a 'one off' development with no repetition or regularity. You have no history of property development. You will have no active involvement in the development, engaging a third-party builder and project manager to handle the process.

Consequently, it is the Commissioner's view that the profit from the sale of the two townhouses will not be assessable as ordinary income under section 6-5 of the ITAA 1997 as a result of carrying on a business of property development.

Isolated commercial transaction with a view to a profit

Profits from isolated transactions will be assessable as ordinary income where the intention or purpose in entering into the transaction was to make a profit or gain, even though the transaction may not be part of the ordinary activities of the taxpayer's business (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium).

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income sets out the Commissioner's view as to the application of the decision in Myer Emporium and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5.

Paragraph 1 of TR 92/3 outlines that isolated transactions are:

   • those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

   • those transactions entered into by non-business taxpayers.

If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but:

   • the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and

   • the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

Paragraph 12 of TR 92/3 states that for a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character.

TR 92/3 makes it clear at paragraph 42 that even if a taxpayer did not originally acquire a property with a profit-making intention, the profit made on its eventual sale will be income if the taxpayer later ventured the property into a profit-making commercial transaction:

42. For example, if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either:

   (a) as the capital of a business; or

   (b) into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction,

the activity of the taxpayer constitutes the carrying on of a business or a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

If a property is entered into a property development sometime after it was acquired, it is the taxpayer's intention at the time the property is committed to the development that must be considered.

In considering the taxpayer's intention, TR 92/3 states that it is not the subjective intention or purpose of the taxpayer that is relevant. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

In determining whether activities relating to isolated transactions are a profit-making undertaking or are the realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. There can be several factors for consideration:

   • The extent of work being done to the land. The more work being done to the land the more it leads to the conclusion that the activity has a business or profit-making intention.

   • The financial risk in respect of the development. The more financial risk there is for the land owner, the more likely that the activity or development is a business or profit-making development.

   • Cost of the development relative to the value of the land. Where the associated costs of the development are significant relative to the value of the land being developed, the more likely it is that the development amounts to a business activity or one of profit-making.

Application to your circumstances

You have clearly stated that your intent with respect to the two townhouses that you plan to sell is to repay the construction loan and cover taxes. That is, the sale of the two townhouses will fund the entire development and enable you to retain the other two townhouses. In this way you intend to profit from the sale of two townhouses.

The property currently consists of one dwelling on the land. Your intent is to demolish that dwelling and build four dwellings on it. This represents a significant change in the nature of the asset and when two of the townhouses are sold, it will not be a mere realisation of the original asset, but essentially two new assets that are being sold.

Your intent is to take out a $X dollar construction loan to finance the build, half of which will relate to the two townhouses you intend to sell. There is a significant financial risk in the undertaking,

You have estimated that the development costs will be around $X dollars and advise the current property valuation is approximately $X dollars. The development costs are not low relative to the value of the land. The building of the townhouses will not be a simple enhancement of the property, but rather a substantial part of the value of the property that will be sold, lies in the townhouses that will be constructed on it.

Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that the sale of two of the four townhouses to be built at Address A will not be a mere realisation of a capital asset. Rather, the sale of the two townhouses is considered to be part of an isolated commercial transaction entered into with a view to a profit and therefore the resulting profit will be assessed as ordinary income under section 6-5 of the ITAA 1997.

Assessable under capital gains tax provisions

The capital gains tax (CGT) provisions are contained in Parts 3-1 and 3-3 of the 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.

Section 102-20 of the ITAA 1997 provides that a capital gain or loss happens only as a result of a CGT event. The most common event is CGT event A1 which happens when a person disposes of a CGT asset to someone else under section 104-10 of the ITAA 1997. CGT assets include real estate.

The inclusion of the profit or gain on the sale of a CGT asset as ordinary income does not mean that a CGT event does not happen in relation to the asset. However, section 118-20 of the ITAA 1997 operates to ensure that amounts which are assessable income under another provision of the act, outside of the CGT provisions, are not also taxed as capital gains.

Therefore, while CGT event A1 will occur when an asset is sold, any capital gain will be reduced by the amount included as ordinary assessable income under section 6-5 of the ITAA 1997.

Application to your circumstances

While CGT event A1 will occur on the sale of each of the two townhouses, any capital gain made on their disposal will be reduced to the extent that the profit from the sales will be included in your assessable income under section 6-5 of the ITAA 1997.

Additional Information

Calculation of the profit on the sale of the two townhouses in the short term

Where land was previously held for private purposes but is later ventured into an isolated commercial transaction for profit-making purposes involving subdivision of the land and development into multiple properties, the calculation of the net profit on the sale of a developed property will include a reduction for the market value of the relevant portion of the land when it was ventured into the development. This is in line with the decision in Whitfords Beach Pty Ltd v. Federal Commissioner of Taxation (1983) 67 FLR 151; (1983 14 ATR 247; 83 ATC 4277. The profit calculation will also take into account the portion of the construction costs related to the townhouse sold.

Calculation of the capital gain on the sale of the two townhouses in the short term

As mentioned previously, although the profit on the sale of the two townhouses in the short term will be assessed as ordinary income, CGT events will still happen on the sales. However, the capital gain on each sale will be reduced by the profit on the sale that is assessable as ordinary income under section 6-5 of the ITAA 1997.

The calculation of the capital gain will be different to the profit calculation discussed above. Unlike the profit calculation discussed above, the CGT calculation will not take into account the market value of the land when it was ventured into the development.

The capital gain will be calculated in accordance with the CGT provisions in Part 3-1 of the ITAA 1997. The first element of the cost base of each townhouse will include part of the purchase price of the original property apportioned on a reasonable basis (section 112-25 of the ITAA 1997). The fourth element of the cost base of each townhouse will include the portion of the construction costs that relate to that townhouse.

The 50% CGT discount will apply in calculating the capital gain as you acquired the original property that was subdivided, more than 12 months ago. 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)? states that subdivided lots are treated as separate assets but taken to have been acquired when the original property was acquired.

Future CGT on the remaining two townhouses that will be held long term

Where the remaining two townhouses are sold in the future after being held on a long-term basis, each sale will be a CGT event. The CGT information provided above will also apply to the calculation of the capital gain on these townhouses. In addition, for the townhouse that you will use as your home, the main residence CGT exemption will apply. However, you may need to consider if a partial exemption is applicable. When you sell the two remaining townhouses in the future, if you are unsure about how CGT will apply, you may request a private ruling on the matter at that time.