Private ruling: CGT - property development
Published: September 2014
Ruling period: Year ending 30 June 2015 | Year ending 30 June 2016
Date scheme commenced: 1 July 2014

Ruling: Q1: Will the profit you make on the development of your main residence into units be ordinary income pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Will the profit you make on the development of your main residence into units be accounted for under the capital gains tax (CGT) provisions? | A2: No. | Q3: Will the development be subject to the trading stock provisions contained in Division 70 of the ITAA 1997? | A3: No. | Q4: Will the property become trading stock at the time the property development begins? | A4: Not applicable.

Relevant facts and circumstances: You purchased a block of land pre-CGT and built your home on it in pre-CGT. You purchased a one half interest in the property post-CGT from your former spouse. This property has been your principle place of residence. You propose to develop the land by building a number of units and convert your existing house into a further number of units. You plan to live in one of the units converted from your existing house. At the end of the development, the unit will be sold and you will retire to another location. The development will be undertaken in stages due to financial constraints. You hope to complete the first stage by the end of the 2014 financial year. A registered builder has been engaged to undertake the construction work. The first stage of units will then be offered for sale through a registered real estate agent. You hope the house can be converted into units by the middle of the 2015 financial year. You intend to live in one of these units and sell the other. You intend to make a profit from this development venture, in order to fund your retirement. Construction on the final units is likely to commence late in the 2015 financial year and completed in the 2016 financial year. It is expected they will be sold in the 2016 financial year. You are not involved in the construction industry. You have not and do not intend to undertake any further property development ventures.

Relevant legislative provisions: Income Tax Assessment Act 1997 (ITAA 1997) section 6-5 | Income Tax Assessment Act 1997 (ITAA 1997) section 118-20 | Income Tax Assessment Act 1997 (ITAA 1997) section 70-10 | Income Tax Assessment Act 1997 (ITAA 1997) section 70-30

Reasons for decision: Summary: There are three ways profits from a land sub-division and/or property development 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, involving the sale of land as trading stock. (2) As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated commercial transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business, which is the commercial exploitation of an asset acquired for a profit making purpose. (3) As statutory income under the capital gains tax (CGT) legislation, (sections 10-5 and 102-5 of the ITAA 1997), on the basis that a mere realisation of a capital asset has occurred. | Detailed Reasoning - Isolated Transaction: Taxation Ruling TR 92/3 is about whether profits on isolated transactions are of a commercial nature that fall on revenue account. Here, in relation to the disposal of property, paragraphs 9 and 49(g) state: The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property. … In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations. Some factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are the following: … (g) if the transaction involves the acquisition and disposal of property, the nature of that property ( Edwards v. Bairstow ; Hobart Bridge 82 CLR at 383). For example, if the property has no use other than as the subject of trade, the conclusion that the property was acquired for the purpose of trade and, therefore, that the transaction was commercial in nature, would be readily drawn… In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135 ( Casimaty ), the legal principles in relation to the subdivision of land were discussed at length. In concluding his judgment that the subdivision of the taxpayer was a mere realisation of a capital asset, Justice Ryan said, at 97 ATC 5152: Nor did the taxpayer undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks. Had he constructed dwelling houses , internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement. [Emphasis added] In your case, the redevelopment your property will be an isolated commercial transaction assessable as ordinary income under section 6-5 of the ITAA 1997. You entered into the redevelopment of your main residence into units with the intention to maximise the value of your home in order to fund your retirement. We consider the level of development to your property exceeds that which is necessary to merely realise a capital gains asset. This is because the units that will be built (and thus acquired) will have no use other than as a subject of trade (as stated in paragraph 49(g) of TR 92/3. This outcome is affirmed in the judgment of Casimaty , which held the subdivision of land with the construction of dwelling houses is a commercial (business) venture. | Detailed Reasoning - Capital Gains: Section 118-20 of the ITAA 1997 primarily exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. In the absence of such a provision, it is conceivable that a receipt properly characterised as ordinary income and which has also been derived as a result of a CGT event could result in the receipt being taxed twice. Therefore, whilst a CGT event A1 occurs when the property is sold, any capital gain will be disregarded to the extent of any amount already included as ordinary assessable income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Trading Stock: Section 70-10 of the ITAA 1997 provides that trading stock includes anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business. Taxation Determination TD 92/126 states land can only be treated as trading stock if a business of trading in land is actively being carried on. There must be a present the continuity of activity which characterises a business. Taxation Determination TD 92/126 states if, in an isolated commercial transaction, land is acquired for the purpose of development, subdivision and sale, even though net profit made on the sale of the land is assessable as ordinary income, the land is not treated as trading stock because a business of trading in land was not commenced. In your case, you are not considered to be carrying on a business of property development. Your activity is considered part of an isolated transaction and as it follows your property is not trading stock. You are not considered to be carrying on a business of property development and as such the house and land is not considered trading stock. Accordingly, it is not relevant to consider when the house and property would become trading stock, for valuation purposes.