Private ruling: Property subdivision and the main residence exception
Date of advice: 7 December 2018
Published: March 2019
Ruling period: 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Will any profit you make from the sale of your ownership interests in Property X be treated as ordinary income under section 6 -5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: Are the proceeds from the sale of your ownership interests in Property X subject to capital gains tax (CGT) under Parts 3-1 and 3-3 of the ITAA 1997? | A2: Yes | Q3: Can you apply the main residence exemption on the sale of your ownership interests in Property X? | A3: Yes

Relevant facts and circumstances: You purchased Property X in 20XX consisting of a house and land. The property was specifically chosen as you wished to sub-divide into two lots, the first being the current house and small area of land and the second lot a larger area of land. The second lot would be Property Y. The intention of the transactions was to allow you to find an appropriate property with a current residence to live in, subdivide to build their dream home (using superannuation monies) and then sell the original residence and replenish your superannuation accounts. The second lot of land was used to build your dream retirement home, which was built over a period of 3-4 years. Initially you incurred costs in relation to improvements undertaken on the original property as the dwelling would be your main residence for a number of years. You also incurred costs on the development application to split the lots. From the initial purchase date, during the construction phase and up to the sale date Property X was used as your main residence. The property was never rented. On completion of the new dwelling Property Y you moved into these premises which became your new main residence and the original property (Property X) was placed for sale, and was sold in 20XX7. You did not treat any other property besides Property X as your main residence when you were living there. You never used Property X to produce assessable income. The land situated under Property X is less than two hectares.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Part 3-1 | Income Tax Assessment Act 1997 Part 3-3 | Income Tax Assessment Act 1997 Subdivision 118-B

Reasons for decision: Summary: Profits from the sale of Property X would be assessable as capital gains under Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997). You are entitled to apply the main residence exemption to any gains derived from the sale of Property X. | Detailed Reasoning - Question 1: Ordinary income: There are three ways profits from property sales can be treated for taxation purposes: 1. As ordinary income under section 6-5 of the ITAA, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock; or 2. As ordinary income under section 6-5 of the ITAA, on revenue account, as a result of an isolated business 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; or 3. As statutory income under the capital gains tax legislation. Under section 6-5 of the ITAA 1997, the assessable income of an Australian resident includes ordinary income derived both in and out of Australia during an income year. Ordinary income is defined as income according to ordinary concepts. In FC of T v The Myer Emporium (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 (Myer Emporium), the Full High Court expressed the view that profits made by a taxpayer who enters into an isolated transaction with a profit making purpose can be assessable income. Taxation Ruling TR 92/3 considers the assessability of profits on isolated transactions in light of the principles outlined in Myer Emporium. According to Paragraph 1 of TR 92/3, the term isolated transactions refers to: ● those transactions outside the ordinary course of business of a taxpayer carrying on a business, and ● those transactions entered into by non-business taxpayers. ● Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction will generally be income when both the following elements are present: ● your intention or purpose in entering into the transaction was to make a profit or gain, and ● the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction. In contrast, paragraph 36 of TR 92/3 notes that the courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment. | Detailed Reasoning - Application to your situation: In you case, you do not carry on a business of buying, selling or developing land. There is a lack of regularity and repetition of the activity as there is no trading pattern of buying, developing and selling land. It is also considered that your transaction does not reach the level of becoming an isolated commercial transaction or profit making undertaking. Property X was sold after solely being your main residence. You used that dwelling to live in whilst your other house was built. You made improvements to the property for your benefit before you commenced living in it. These do not appear to be for the predominant purpose of reselling. Any gain made on the disposal of the property will not be assessable income under section 6-5 of the ITAA 1997 as ordinary income from the carrying on of a business or from an isolated commercial transaction or profit making undertaking. | Detailed Reasoning - Question 2: Capital Gains Tax: The CGT provisions are contained in Part 3-1 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. CGT event A1 under section 104-10 of the ITAA 1997 happens if you dispose a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property. Where an amount is included in your income as ordinary income, it will not also be treated as a capital gain. When a CGT asset (the original asset) is split into two or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided blocks is not a CGT event. Where the original land was acquired after 20 September 1985, each new subdivided block retains its post-CGT status and will be viewed as having been acquired on the same date the original asset was acquired. You will make a capital gain if the capital proceeds received for the asset are more than the asset’s cost base. You will make a capital loss if the capital proceeds received for the asset are less than the asset’s cost base. | Detailed Reasoning - Application to your circumstances: As outlined above, it is not viewed that any profit made on the disposal of Property X will be assessable as a result of you carrying on a business or from a profit making undertaking. Therefore any gain made on the disposal of Property X will be assessable under Parts 3-1 and 3-3 of the ITAA 1997. | Detailed Reasoning - Question 3: Main Residence: Under section 118-110 of the ITAA 1997, you can generally disregard any capital gain or capital loss from a CGT event that happens to a dwelling that is your main residence for the entire period you owned it when: ● the dwelling was your home for the whole period you owned it; ● the dwelling was not used to produce assessable income; and ● any land on which the dwelling is situated is not more than two hectares. In your case, Property X was your main residence during the whole period you owned it, it was not used to produce income and any land on which the dwelling is situated was not more than two hectares. Accordingly you are entitled to disregard the entire capital gain upon the sale of Property X, if one were to arise.