Private ruling: Lease surrender payment
Date of advice: 10 October 2025
Published: 24 November 2025
Ruling period: 1 July 20XX to 30 June 20XX
Date scheme commenced: XX/XX/20XX

Ruling: Q1: Will the Termination Payment be included in the calculation of a capital loss for you? | A1: No. | Q2: Can you include the Termination Payment in the cost base of the Property? | A2: No.

Relevant facts and circumstances: You purchased the Property more than 20 years ago for $XXX,XXX which you used as a rental property from acquisition. Approximately a decade ago, you and your adult child (C) mutually agreed that they would purchase the Property from you. However, you had tenants in the Property at the time and did not want to evict them so you both agreed to wait until the tenants left. There is a record of a message between you and C about 5 years ago with you agreeing that C could purchase the Property. However, C was not given the keys until XX/20XX when the tenants moved out of the Property. You estimate that the market value of the Property at this time based on rates notices was approximately $XXX,XXX. After the tenants moved out in XX/20XX, you and C undertook renovations to the Property until C moved into the Property on XX/XX/20XX. There was no written agreement regarding this period. There was a verbal agreement that you and C would renovate the property and then C would move in. C made the decisions regarding the renovations and paid for them. However, you both carried out some of the renovations yourselves to save on costs. The expectation was that C would buy the Property when they had the funds to. You estimate that the market value of the Property when C moved into the Property on XX/XX/20XX based on rates notices was approximately $XXX,XXX. The amount you owed on your mortgage on the property at this time was approximately $XXX,XXX. Since moving in, C has not paid a commercial rate of rent but has been paying the rates and land tax. You have continued to make the mortgage payments. You and C signed a written document dated XX/XX/20XX that was titled 'Residential Tenancies Agreement' (the written lease). The written lease states that it formally records the lease which commenced approximately 18 months earlier on XX/XX/20XX. The applicant law firm (your adviser) representing you and C in this matter has confirmed that the terms of the written lease were not changed from the verbal lease agreement and the written lease merely reduced to writing the terms of the verbal lease agreement as you and C understood them to be. The original written lease included the following terms: • Annual rent of $XX (clause 4.1.2). • The lease period is XX years (clause 2.11). • The lessee agrees to undertake any repairs to the Property except for damage caused by fire, flood, lightning, storm, tempest, inevitable accident, act of God, war, intentional acts or negligence (clause 4.3). • The lessor agrees to 'maintain the Property in a reasonable state of repair and abide by all legal requirements regarding the buildings and health and safety in respect of the Property' (clause 5.2) • The lessor agrees to bear all costs concerning rates and taxes in respect of the Property (clause 5.7). • The lessor agrees not to unreasonably withhold consent for subletting or assignment (clause 5.8). • The lessee may terminate the lease early with written permission of the lessor (clause 8.3). • The lessor may terminate the lease at any time but must pay the lessor a 'Termination Payment' (clause 8.4). • The lease is terminated automatically on the sale of the Property by the lessor, in which case the lessor must pay the lessee the Termination Payment (clause 8.5). • Calculation of the Termination Payment under clauses 8.6 to 8.10 is as follows: - Termination Payment = PMT ((1-(1+ (i - g)) -n )/(i-g)). - PMT means the annual market value rent determined at the Termination Date. - 'n' means the number of years remaining from the Termination Date rounded to whole number of years. - 'I' means the standard 25 year variable home loan interest rate on the current mortgage or if no mortgage, the mean rate between CBA, NAB, ANZ and Westpac. - 'g' means the CPI for the quarter preceding the Termination Date. The explanation provided for the arrangement was as follows: • As C did not have the funds to purchase the Property, you and C wished to enter into an alternative arrangement so that C would receive the benefit of the Property from that point, including the use of the Property and any increase in value from when C moved in. And as C would be having the use and benefit of the Property, they would be taking over responsibility for the Property. That is, you and C sought an alternative arrangement which would result in C effectively becoming the 'real' owner of the Property for economic and practical purposes. • You and C consulted with your adviser who recommended that you both enter into a long term lease with a lease surrender payment (the 'Termination Payment'). • Your adviser explained that the Termination Payment is the mechanism for C to receive the benefit of the increase in value of the Property from when C first moved in. • In case you and C had a falling out, the lease arrangement protects C as it binds you to your agreement that C would receive the benefit of the use of the property and its increase in value. • Your adviser believed the arrangement utilising the lease with the Termination Payment would result in a similar CGT outcome compared to if C had been able to fund the purchase of the Property from you. That is, you would remain liable for the capital gain from your original acquisition until the commencement of the arrangement with the effect of the Termination Payment being to shift the CGT liability for the further increase in value from you to C. Your adviser expected that C would be entitled to the main residence exemption that would allow C to disregard the capital gain they would make on the receipt of the Termination Payment You estimate that the current market value of the Property based on rates notices is $XXX,XXX. We asked for examples to demonstrate how the calculation of the Termination Payment worked and confirmation of who has been paying for the mortgage, rates and taxes in relation to the Property since the arrangement commenced. Subsequently, on XX/XX/20XX we were provided with an 'Agreement to Vary the Residential Tenancies Agreement' (the Variation Agreement) signed by you and C that stated: I. although Clause 8.6 captures the intention of the Parties, they are of the view that the description of the meaning of 'g' in Clause 8.10 creates ambiguity and is inconsistent with the appropriate calculation of net present value; and II. Clause 5.7 is a mistake and does not reflect the agreement made between the Parties. The Variation Agreement also states that you and C agree to amend the written lease by: • Deleting the current definition of 'g' and replacing it with 'the annual change in the CPI, expressed as a percentage, calculated by comparing the CPI published for the quarter immediately before the Termination Payment with the CPI published for the same quarter 12 months prior'. • Deleting Clause 5.7 and inserting Clause 4.12 which states 'the Lessee agrees to bear all costs concerning Rates and Taxes in respect of the Property'. In the example provided where the lease was terminated now and using the revised definition of 'g', the Termination Payment was calculated as $XXX,XXX. The examples provided implied that you and C had agreed that the arrangement would result in C being responsible to any capital gain accruing after XX/20XX when the previous tenant vacated the Property and when we asked for clarification, this was confirmed as being the agreement. When asked for clarification of the apparent conflict between clauses 4.3 and 5.2 of the written lease regarding who was responsible for repairs, your adviser stated that: C is responsible for repair and maintenance of the property in accordance with clause 4.3-4.5, except where the lessor has a statutory obligation to maintain (refer clause 4.5). Clause 4.6 requires C to notify the lessor of accidents, defects or broken items but does not make the lessor responsible for rectifying these issues. The lessor is only responsible if there is a statutory obligation on them to rectify the issues. C expects to be able to obtain finance to purchase the Property within the next few years and will then offer to purchase the Property from you. If you both agree on the price, C will obtain the necessary finance and will enter into a contract for sale with you. You will then terminate the written lease which will trigger clause 8.4 and make the Termination Payment to C. You will transfer title to the Property to C and you will receive the agreed sale price from C.

Relevant legislative provisions: Income Tax Assessment Act 1997 paragraph 110-25(2)(a) | Income Tax Assessment Act 1997 subsection 112-25(4) | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 section 112-20

Reasons for decision: Summary: Taxation Ruling TR 2005/6 Income tax: lease surrender receipts and payments states: 26. A lessor who makes a lease surrender payment obtains a conveyance or transfer of a lease and can include the payment in the cost base of that CGT asset (being the lease) under paragraph 110-25(2)(a). The lease surrender payment is the money paid in respect of acquiring that asset from the lessee. Generally, when a lease is transferred to a lessor who owns the reversionary interest in the land, the term of the lease merges into the land. The cost base of the merged asset is calculated in accordance with subsection 112-25(4) and includes the cost bases of the land and the lease acquired from the lessee. 27. CGT event C2 in section 104-25 of the ITAA 1997 also happens to the lessor in relation to the discharge of its contractual rights under the lease agreement. As no capital proceeds are received for the discharge, the lessor may make a capital loss to the extent to which the reduced cost base of the rights asset (which could include incidental costs and any non-deductible incentive paid to the lessee on the grant of the lease) exceeds its market value, if any (section 116-30), however it is unlikely that the market value would be other than a negligible amount. That is, TR 2005/6 states that a lease surrender payment made by a lessor is included the cost base of the property that was the subject of the lease rather than in the calculation of any capital loss for the C2 event on the ending of the lessor's rights under the lease. In any case, as explained in detail further below, the arrangement between you and C is considered to be a private family matter rather than a legally enforceable contract and therefore does not result in tax consequences. TR 2005/6 considers lease surrender receipts and payments in the context of leases entered into on an arm's length commercial basis. The arrangement between you and C is clearly not an arm's length commercial transaction given the annual rent payable is only a nominal figure. This raises concerns as to whether your arrangement is a valid contract. An invalid contract is not legally effective and consequently has no tax consequences ( Jacques v. FC of T (1924) 34 CLR 328; FC of T v. Newton (1957) 96 CLR 577; FC of T v. Just Jeans Pty Ltd [1987] FCA 218). Essential requirements for a valid contract in Australia include: (a) Consideration (b) Certainty of terms (c) An intention by all parties to be legally bound | Detailed Reasoning - (a) Consideration: The explanation provided for the arrangement was that it was to effectively make C the 'real' owner of the Property for economic and practical purposes. C would benefit from its use and its future increase in value through receipt of the Termination Payment in exchange for a nominal annual rent of $XX per year and being responsible for the Property through paying the Property's ongoing costs such as rates, taxes and repairs. As the annual rent amount is negligible, the consideration payable by C for the use and increase in value of the Property largely consists of paying the Property's ongoing costs. In order for consideration to be valid, it must not violate any existing laws. The residential tenancy legislation in the relevant State stipulates that the landlord must bear all statutory charges except for charges for certain prescribed services being electricity, gas, telephone, internet, subscription television and water. That is, the lessor (property owner) must pay council rates, land tax charges, sewerage charges and any levies. Therefore, clause 4.12 inserted by the Variation Agreement which states that 'the Lessee agrees to bear all costs concerning Rates and Taxes in respect of the Property' is contrary to the applicable residential tenancy legislation and unenforceable. Also, that legislation states that it is the landlord's obligation to ensure that the property is in a reasonable state of repair, in addition to complying with any statutory requirements affecting the property. Therefore, clause 4.3 which places an obligation to repair on C violates residential tenancy legislation. In summary, C's consideration under the agreement to pay for the rates, taxes and repairs for the Property contravenes existing law. | Detailed Reasoning - (b) Certainty of terms: Another requirement for a valid contract is that its terms must be clear, certain and able to be understood by both parties. In response to a request for clarification of the apparent conflict between clauses 4.3 and 5.2, we were advised that C is responsible for repairs unless you had a statutory obligation. However, clause 5.2 states that the lessor agrees to: maintain the Property in a reasonable state of repair AND abide by all legal requirements regarding the buildings and health and safety in respect of the Property. (emphasis added) That is, clause 5.2 states that in addition to abiding by statutory requirements, you agree to 'maintain the Property in a reasonable state of repair'. This is contrary to clause 4.3 and your adviser's statement that C is responsible for repairs unless you had a statutory obligation. In any case, as discussed above, you as the property owner have a statutory obligation to undertake all repairs and therefore the purported transfer of responsibility for any repairs is ineffective. One of the other fundamental aspects of the agreement is the Termination Payment. We have been advised that the terms of the written lease were not changed from the verbal lease agreement and the written lease merely reduced to writing the terms of the verbal lease agreement as you and C understood them to be. Therefore, the Termination Payment was part of the verbal lease agreement. However, the formula for the Termination Payment is a very complex calculation. In fact, your adviser had not realised that the formula required amendment until we asked for examples to demonstrate how the formula worked. Given its complexity and how difficult it would be for those not working in the finance field to understand, we do not see how it could have formed part of the verbal agreement between you and C that was entered into 18 months before the written lease was drafted that included the Termination Payment formula. Also, it is now unclear as to what the Termination Payment is for. Your adviser originally informed us that the purpose of the Termination Payment was as a mechanism for C to receive the further increase in value of the Property from when the lease commenced. However, the Variation Agreement entered into after we queried some of the written lease's terms refers to the Termination Payment representing the net present value of the lease. This is very different to the increase in value of the Property from the commencement of the lease until it is terminated. In fact, it would be expected that the net present value of the lease for the lessee in this case would diminish over time as the remaining lease term shortened whereas the increase in value of the Property would be expected to grow over time. The Termination Payment formula appears to be more reflective of the net present value of the lease for the lessee rather than the increase in value of the Property during the lease. If the Termination Payment was intended to represent the latter, then it could simply have been defined as the difference between the Property's market value when the lease is terminated and its market value when the lease was entered into. When the Termination Payment was explained as the method to facilitate the part of the agreement that C was to benefit from the increase in value of the Property in exchange for taking on responsibility of the Property's ongoing expenses, then it's purpose was understandable. However, if the Termination Payment was actually intended to be the net present value of the lease and so has no correlation to the increase in value of the Property, then its purpose is unclear. Another uncertain element of the purported contract between you and C is when it commenced. We were originally advised that the purpose of the lease was to provide C with the benefit of the Property from when it commenced on XX/XX/20XX, both through the Property's use for negligible rent and the Property's further increase in value through the Termination Payment. However, later we were advised that the agreement between you and C was that C was to benefit from the increase in value from when the previous tenants moved out in XX/20XX rather than when C moved in approximately a year later on XX/XX/20XX. This indicates that your agreement with C began when the previous tenants moved out; however, the lease which supposedly constitutes the agreement commenced a year later. Also, C's obligations under the arrangement only began when the lease commenced on XX/XX/20XX whereas we're now advised C was to benefit under the arrangement through the increase in value of the Property from when the previous tenants moved out in XX/20XX. It is unclear as to why C was to benefit from the Property for a period of a year before the commencement of the obligations C agreed to take on in exchange for that benefit. If it was because C was paying for renovations to the Property during that period, then it is still unclear if the responsibility for the Property's other costs during that year, such as rates and taxes, were also passed on to C or remained with you. With respect to the renovations during that year long period, C made the decisions about the renovations and financed them but you both completed some of the work to save on costs. The renovations represent a significant undertaking in relation to the Property and would have been part of the agreement/understanding between you and C concerning the Property. However, this aspect of the agreement between you and C is not included in the lease which is claimed to constitute the agreement. | Detailed Reasoning - (c) An intention by all parties to be legally bound: Given the minimal amount of rent payable, C's key obligation under the agreement in exchange for benefitting from the Property was to pay for the Property's ongoing expenses, primarily the rates and taxes. However, the original written lease stated that you were responsible for the rates and taxes and this was only changed after we queried it. The fact that the clause which covered such a central aspect of the agreement between you and C was not checked by either of you to ensure its correctness casts doubt on whether either of you intended to be legally bound by the written lease. As mentioned previously, your adviser has confirmed that the terms of the written and verbal lease agreements are the same so the Termination Payment clause was part of your verbal lease agreement with C. However, as also discussed, we do not consider it was possible for you and C to have verbally agreed to the calculation of the Termination Payment given its complexity. It is also noted that the calculation of the Termination Payment has great consequence as it results in an amount payable in the several hundreds of thousands of dollars. It is considered unlikely that parties would verbally enter into a legally binding agreement on an intricate multifaceted calculation that results in an amount payable of such magnitude. It is noted that you and C first agreed for C to purchase the Property from you approximately a decade ago and the agreement was reaffirmed over the years. However, the agreement was not put to writing until recently when the written lease was signed. Also, as noted previously, there were significant aspects of the dealings between you and C regarding the Property, such as the renovations and Property costs from XX/20XX to XX/XX/20XX, that were not dealt with in the documented agreement. Having regard to all the circumstances, it is considered that the arrangement between you and C is more accurately characterised as an informal family matter that has evolved and changed over time rather than a formal contract that you and C intended to be legally bound by. | Detailed Reasoning - Conclusion: We do not believe the lease between you and C to be a valid contract for several reasons. Firstly, the primary consideration payable by C under the lease is contrary to the applicable residential tenancy legislation and therefore not enforceable. Secondly, there is substantial uncertainty as to several key terms of the agreement. Finally, we do not consider that you and C intended to be legally bound by the documented lease terms when the arrangement was entered into. That is, we believe you and C entered into an informal family arrangement rather than a legally binding contract. As the lease is not a valid contract, it is not legally enforceable and therefore does not result in any tax consequences. | Detailed Reasoning - Additional information: As discussed previously, TR 2005/6 states that on the surrender of the lease, the lessor obtains a conveyance of the lease and generally includes the lease surrender payment they made in the cost base of the lease. However, where the parties did not deal with each other at arm's length, the market value substitution rule provided by section 112-20 of the ITAA 1997 will apply to deem the first element of the cost base of the lease to be the market value of the lease. The market value of the lease for the lessor is the present value of the future lease amounts payable under the lease. Therefore, in this case even if the lease was considered to be a legally binding contract that was legally effective, the market value substitution rule would apply to limit the first element of the cost base of the lease to the market value of the lease. In this case, the market value of the lease for you is the present value of the future lease amounts of $XX per year payable under the remaining term of the lease. That is, it is that amount rather than the Termination Payment that would be the first element of the cost base of the lease and added to the cost base of the merged asset (being the Property merged with the remaining term of the lease).

Does IVA apply to this private ruling?: Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement. | If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax. | We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part. | If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply. | For more information on Part IVA, go to our website ato.gov.au/gaar .