Private ruling: Capital gains tax - subdivision - disposal
Date of advice: 9 July 2015
Published: July 2015
Ruling period: Year ending 30 June 2015.
Date scheme commenced: 1 July 2014.

Ruling: Q1: Will the cost base of the vacant block of land be calculated using the method outlined in section 112-25 of the Income Tax Assessment Act 1997 ? | A1: Yes.

Relevant facts and circumstances: You purchased a vacant block of land (Block A) after 20 September 1985 with the intention of building a dwelling on it. You incurred costs to clear rocks in relation to the preparation of Block A for the construction of a dwelling. A dwelling was built on Block A. At the time the dwelling was built, Block A had been unavailable for subdivision. A number of years later, you were advised by Council that they would permit the subdivision of Block A. You decided to subdivide Block A into two blocks a number of years later after you had experienced some health issues. Your intention had been to build a dwelling on the vacant block of land. Block A was subdivided resulting in Lot A, which had the existing dwelling located on it, and Lot B a vacant block of land. You did not undertake any actions in relation to Lot B for a number of years until you again incurred expenses associated with building a dwelling on the vacant block of land. You experienced health issues again and decided not to proceed with your plans to build a dwelling on Lot B. After you had recovered from your health issues, you decided to retain Lot A and dispose of Lot B. You have disposed of Lot B and have made a capital gain.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 102-20 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 110-25 | Income Tax Assessment Act 1997 Section 112-25 | Income Tax Assessment Act 1997 Section 115-5 | Income Tax Assessment Act 1997 Section 115-10 | Income Tax Assessment Act 1997 Section 115-15 | Income Tax Assessment Act 1997 Section 115-20 | Income Tax Assessment Act 1997 Section 115-25 | Income Tax Assessment Act 1997 Section 115-100 | Income Tax Assessment Act 1997 Section 118-110 | Income Tax Assessment Act 1997 Section 118-120 | Income Tax Assessment Act 1997 Section 118-160 | Income Tax Assessment Act 1997 Section 118-165

Reasons for decision: Detailed Reasoning - Main residence exemption and land adjacent to your dwelling: Capital gains tax (CGT) is tax you pay when a CGT event happens to a CGT asset, such as land. The most common CGT event is CGT event A1, which occurs when you dispose of your ownership interest in a CGT asset to another party, such as when you sell the land (section 104-10 of the ITAA 1997). Generally, you can ignore a capital gain or capital loss you make from a CGT event that happens to a dwelling that is your main residence (section 118-110 of the ITAA 1997). The main residence exemption can include land adjacent to the dwelling to the extent that it is used primarily for private or domestic purposes in association with the dwelling. The maximum area of land that is covered by the main residence exemption, including the area under the dwelling, must not exceed 2 hectares (section 118-120 of the ITAA 1997). If you dispose of adjacent land to the same person at the same time as you dispose of your main residence, the exemption extends to the adjacent land. However, if you dispose of adjacent land at a different time than you dispose of your main residence, the exemption does not apply to the adjacent land (section 118-165 of the ITAA 1997). | Detailed Reasoning - Application to your situation: In your case, CGT event A1 occurred when you disposed of Lot B. However, this CGT event did not happen to Lot A on which your main residence was located. Therefore, as you did not dispose of a dwelling at the same time as you disposed of the vacant block of land you will not be able to apply the main residence exemption to the disposal of Lot B in accordance with section 118-165 of the ITAA 1997. | Detailed Reasoning - Destruction of dwelling and sale of land: If your main residence is accidentally destroyed and you then dispose of the vacant land on which it was built, you can choose to apply the main residence exemption as if the dwelling had not been destroyed and continued to be your main residence (section 118-160 of the ITAA 1997). | Detailed Reasoning - Application to your situation: In this case, no existing dwelling had been destroyed on the Lot B. Therefore, you are not eligible for this exemption to disregard any capital gain made on the disposal of Lot B. | Detailed Reasoning - Subdivision of Land: If a taxpayer subdivides a block of land, each block that results is registered with a separate title. For CGT purposes, the original land parcel is divided into two or more separate assets. Subdividing land does not result in a CGT event if the taxpayer retains ownership of the subdivided blocks. Therefore, the taxpayer does not make a capital gain or a capital loss at the time of the subdivision. Taxation Determination TD 97/3 provides that the Commissioner will accept any "reasonable" method of apportioning the original cost base between the new blocks. A reasonable apportionment of the cost of the land itself can usually be achieved on an area basis if all the land is of a similar size and market value or on a relative market value basis if this is not the case. However, expenditure forming part of the cost base of the asset is not apportioned if that amount is wholly attributable to a particular asset. For example, if a dwelling existed on an original block of land before it was subdivided into two blocks, the cost of the dwelling would only be included in the cost base of the block on which the dwelling stands. Further, the cost of connecting water, gas and/or electricity to the new block would not be apportioned over both blocks, as it is "wholly attributable" to the new block. Construction expenditure for the new dwelling would form part of the cost base of the block on which it stands (section 112-25 of the ITAA 1997). If the blocks are of unequal market value the Commissioner considers that costs such as survey, legal fees and application fees associated with the subdivision should be apportioned in accordance with relative market values of the blocks. | Detailed Reasoning - Application to your situation: In your case, you subdivided Block A into two blocks. Lot A, on which a dwelling was located, and Lot B which remained as a vacant block of land. Lots A and B became separate assets for CGT purposes as a result of the subdivision. You disposed of Lot B and CGT event A1 occurred. However, this CGT event did not occur to a dwelling. The disposal of the subdivided block is treated as a disposal of an asset in its own right, and not as a disposal of part of an asset. You are not entitled to any exemption or exception under the legislative provisions to disregard the capital gain made on the disposal of Lot B. Therefore, you need to consider the cost base of Lot B. In accordance with section 112-25 of the ITAA 1997, and TD 97/3, the original cost base of Block A needs to be apportioned on a reasonable basis between the two blocks, being Lot A and Lot B. This can be achieved on an area basis if all the land is of a similar size, or market value, or on a relative market value basis if this is not the case. The apportioned amount of the original cost base will be included as the first element of the cost base. Expenses incurred in relation to Block A and the subdivided blocks will need to be apportioned as follows: • expenses incurred in relation to Block A prior to the subdivision will need to be apportioned between the two subdivided blocks • expenses incurred in relation to the building of the dwelling located on Lot A will be wholly attributable to that lot • costs associated with subdivision of Block A should be apportioned between the two blocks • any costs incurred in relation to both Lot A and Lot B should be apportioned between the two blocks; and • any costs incurred wholly in relation to either block should be attributed to the cost base of that block only. Note: As you meet the conditions for the 50% CGT discount as outlined in Division 115 of the ITAA 1997, you will be entitled to reduce the capital gain made on the disposal of Lot B by 50% when determining the net capital gain made in relation to the disposal of Lot B. | Detailed Reasoning - Further issues for you to consider: The following information is provided as written guidance. A taxpayer who relies on guidance will remain liable for any tax shortfall if the guidance is incorrect or misleading and they make a mistake as a result (unless a time limit imposed by the law precludes the liability). However, they will be protected against the shortfall penalty and interest on the tax shortfall provided they relied on that guidance reasonably and in good faith. You must keep records of every transaction, event or circumstance that may be relevant to working out whether you've made a capital gain or capital loss from a CGT event. Penalties can apply if you don't keep the records for at least five years after the event. Keeping adequate records will help you work out your capital gain or capital loss correctly when a CGT event happens. When you acquired assets on or after 20 September 1985, and did not keep records, or your records have inadvertently been destroyed, you will need to try to recreate them. The main thing is to get as many details as possible so you can reconstruct your records.