Private ruling: Compulsory acquisition of land and replacement asset rollover
Published: October 2012
Ruling period: Year ended 30 June 2012 | Year ending 30 June 2013
Date scheme commenced: 1 July 2011

Ruling: Q1: Will the purchase of a residential rental property satisfy the conditions of a replacement capital gains tax (CGT) asset under subsection 124-75(4) of the ITAA 1997? | A1: Yes. | Q2: Will an investment in an property investment trust, exchange traded funds or a managed investment trust satisfy the conditions of a replacement CGT asset under subsection 124-75(4) of the ITAA 1997? | A2: Yes. | Q3: Will the capital improvements carried out on the residual land portion of the property satisfy the conditions of a replacement CGT asset under subsection 124-75(4) of the ITAA 1997? | A3: No. | Q4: Will the professional fees incurred for assessment of compensation arising from the compulsory acquisition of part of the land by an organisation form part of the cost base of the asset under subsection 110-25(3) of the ITAA 1997? | A4: Yes. | Q5: Is the cost base and reduced cost base of the property calculated in accordance with section 112-30 of the ITAA 1997? | A5: Yes. | Q6: Is any capital gain that you make calculated in accordance with section 124-85 of the ITAA 1997? | A6: Yes | Q7: Is the expenditure incurred to replace the CGT asset compulsorily acquired, reduced under section 124-85 of the ITAA 1997? | A7: Yes. | Q8: Does the term "money" in section 124-85 of the ITAA 1997 relate to the gross amount paid? | A8: Yes.

Relevant facts and circumstances: Some time after 20 September 1985 you acquired a small rural property (herein referred to as the property). The property comprised a number of hectares of land, mainly pasture and grazing land, and a house. The property has formed part of your long term investment and retirement strategy and has been rented/leased to tenants for the whole period of your ownership. The house has been rented to various tenants under the management of local real estate agents and the land has been rented to various local cattle owners who have run cattle there on agistment. A few years ago you received a letter from an organisation advising that they intend acquiring a portion of the property. This letter advised that the land would be compulsorily acquired if an agreement could not be reached on price, etc by negotiation. The portion of the property to be compulsorily acquired is a strip of land through the approximate centre of the property which will effectively cut the property into two sections of land. The existing house, house yard and facilities are not so badly affected as this has now been separated into two smaller holdings and there will be no direct access to the rear portion of the land from the front section/house block. Access to the separated or western portion of the land will be gained by driving a short distance along a new access road on the western side of the property The purchase offer subsequently received from the organisation following their inspection and valuation was inadequate and therefore was refused. You then engaged the services of a Licensed Valuer, who prepared a "Compensation Assessment" based on the provisions of the Land Acquisition (Just Terms Compensation) Act 1991 (LAJTC Act 1991). This comprehensive document comprising of some 150-160 pages also included in the assessed compensation, allowances for "disturbance" as provided for under section 59 of the LAJTC Act 1991. In addition to Legal Costs and Valuation fees, this "disturbance" also included claims made for funds to allow construction of the following which were considered necessary and reasonable replacements given that the property has now been split into two sections. The property will now need to be operated differently from before and that further facilities will be needed and should be allowed for in the compensation assessed. There are also some further items of a "depreciable" nature which are not listed here. Negotiations with the organisation continued and some time later, the organisation issued you with a Proposed Acquisition Notice (PAN) advising that if agreement was not reached by a certain date they would then proceed with compulsory acquisition. Shortly afterwards, you agreed to accept a net compensation amount. There were no specified components listed for the compensation amount. Contracts were then prepared and exchanged with settlement taking place shortly afterwards. At settlement you received payment of the agreed amount. Legal and valuer's costs were paid directly to the providers involved. A GST amount was accounted for and included in your BAS for and an amount was paid to the Australian Taxation Office (ATO). Immediately before and at the time of the compulsory acquisition, the house continued to be rented to long term tenants through a local real estate agent and the farm land agisted. You had been undecided initially however some time later you decided to utilize the rollover (or partial to near full rollover) option available for the CGT asset compulsorily acquired. You have placed a tax deductable contribution in your superannuation fund prior to 30 June 2011 from the compensation monies received prior to deciding that you would chose the rollover option. You have not yet acquired all of the replacement assets. You had been working on the assumption that the compensation assessment and therefore the compensation payment received had contained several elements of compensation relating to what you considered to be the repair and reinstatement of the property now damaged and adversely affected by being split into two portions (where part of it was lost or destroyed) by the acquisition. You believed that these items, in the form of capital improvements on the residual portion of the property, would be allowed as "replacement capital assets". The property was now being severely and adversely affected by the compulsory acquisition of a strip of land from the middle of the property which effectively splits it into two portions and introduces various negative aspects in relation to access and visual concept etc. These changes also affect the way the property can be used and there are now further requirements for housing machinery and equipment. With this in mind you have gone ahead and had a new shed built plus substantial extensions added to the existing farm machinery shed. You have also had associated earthworks, hardstand road base areas etc completed. Arranging and supervising this work/construction has taken a considerable amount of time as has other dealing you have had continually with the organisation, and associated groups, as they have required access to the property numerous times in the last few years. The organisation has also recently completed noise amelioration works on the residence which has taken a considerable amount of your time through the planning, quotation, implementation and completion stages. This involved the replacement of most doors and windows in the house and installation of a fully ducted air conditioning system. You have considered purchasing an additional rental property however, none of those looked at to date have fully suited your investment criteria. If the purchase of an additional rental property becomes necessary to satisfy the replacement asset rollover, you would like to look outside the local area for other rental property options. The work carried out at the farm and the organisations access/work requirements have not allowed time for a reasonable search to occur. There are also emotional issues surrounding the compulsory acquisition, as this property has been a "family" property for over 100 years. You are now over 60 years of age and retired so you would prefer not to have to purchase an additional residential rental property as this really does not suit your retirement strategy and current investment requirements. The existing rental property was only partly compulsorily acquired (vacant grazing land comprising a number of hectares only was acquired) by the organisation and therefore the "rental" income continues to be generated from the existing property just as it was before the CGT event. The purchase of an additional rental property would be a long term investment with relatively high costs associated with the acquisition and sale. Further there is a good chance that the capital gain in a new property would be minimal given the time frame available for this investment. The on-going costs associated such as agents fees, rates, insurances and repairs would reduce any income derived and may even result in a negative return. You have been side tracked building in the past year or so and now that the replacement asset requirements is looked into much more closely over the past month or two it is now realised that the sheds built and other capital improvements carried out at the property may not be allowed as a replacement rollover asset. You are considering investing in a property trust, exchange traded fund or managed investment trust in addition to the residential rental property. Your current intention would be to retain any investment made in a property trust for at least a number of years. You believe that investment in a property trust would fully satisfy the requirements for the rollover, similarly to a residential rental property, as: · both are investments in the property market, · income received from an investment property and by the trust is in the form of rents, · there is the prospect of capital growth in both investments, · the risks of each investment are similar, however as the trust has more diversity the risks are lower, · both investments have ongoing costs, i.e. management fees and agents fees etc, · both have costs to enter and leave. You have received more monies for the compulsory acquisition than the amount of monies that you will spend on the replacement assets. You will make a capital gain as a result of the compulsory acquisition before applying any compulsory acquisition rollover. This capital gain will be more than the amount by which the money that you received exceeds the cost of the replacement asset.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104-10, | Income Tax Assessment Act 1997 Section 110-25, | Income Tax Assessment Act 1997 Section 112-30, | Income Tax Assessment Act 1997 Section 124-75 and | Income Tax Assessment Act 1997 Section 124-85.

Reasons for decision: Detailed Reasoning - Replacement CGT asset: Where the original asset was not in any way connected to a business being carried on by you, the replacement asset must be used (for a reasonable period after it is acquired) for the same purpose, or a similar purpose, to the purpose for which the original asset was used just before the event happened. Taxation Determination TD 2000/42 provides some guidance as to the scope of the words 'for the same purpose… or for a similar purpose' that are used in subsection 124-75(4) of the ITAA 1997. | Detailed Reasoning - Application to your circumstances: When establishing whether or not the purchase of another residential rental property, investment in an Australian Real Estate Investment Trust, exchange traded funds or a managed investment trust or the capital improvements made to the residual land will satisfy the requirements under subsection 124-75(4) of the ITAA 1997, consideration must be given as to whether the assets would be 'for the same purpose… or for a similar purpose' as that of your original asset. In your situation, the original asset that you owned was a rental property. Accordingly the purchase of another residential rental property would clearly be considered as being 'for the same purpose' and therefore satisfy the conditions under subsection 104-75(4). If a person 'directly' invests in a rental property it can be said to be used for the purpose of benefiting from rental income and capital growth from real property value. An indirect investment in a property trust can be said to be used for the purpose of benefiting from rental income and capital growth from real property value and can reasonably be viewed as being used for the same purpose or at least 'a similar purpose. Therefore investment in an Australian Real Estate Investment Trust, exchange traded funds or a managed investment trust will also satisfy the requirements under subsection 124-75(4) of the ITAA 1997. The capital improvements that were carried out on the residual land do not qualify as a replacement asset. Paragraph 124-75(2)(a) of the ITAA 1997 provides that you must incur expenditure in acquiring another CGT asset (except a depreciating asset whose decline in value is worked out under Division 40 or deductions for which are calculated under Division 328). By incurring expenditure in completing capital improvements, you are not acquiring an asset but are incurring costs that will either be included in the assets cost base (under the fourth element) or a depreciating asset which is specifically excluded. | Detailed Reasoning - Cost base: Subsection 110-25(3) of the ITAA 1997 provides that the second element of the cost base of an asset includes incidental costs you incur that relate to a CGT event happening to the asset. The professional fees that you incurred in obtaining an assessment of the compensation arising from the compulsory acquisition of part of your land are incidental costs that relate to the CGT event happening and therefore are able to be included in the cost base of the asset. In determining the cost base of the part of the CGT asset compulsorily acquired, the compensation - to the extent to which it reflects the reduction in value of the remaining part of the CGT asset - forms part of the capital proceeds for the CGT event happening to the part of the CGT asset compulsorily acquired for the purposes of subsection 112-30(3) of the ITAA 1997. Subsections 112-30(2), (3) and (4) of the ITAA 1997 provide for apportionment of the cost base of a CGT asset if a CGT event happens to part of the asset and not to the remainder of it. If part of a CGT asset is compulsorily acquired, CGT event A1 happens to the CGT asset representing that part. The cost base of the asset owned before the compulsory acquisition is apportioned in accordance with subsection 112-30(3) of the ITAA 1997, having regard to the compensation received and the market value of the remaining part of the asset. To apply subsection 112-30(3) of the ITAA 1997 you need to determine the capital proceeds for the CGT event happening on the compulsory acquisition. The capital proceeds - for CGT event A1 happening to the CGT asset representing the part of the asset compulsorily acquired - include the amount of the compensation for the compulsorily acquired part to the extent that it reflects the reduction in value of the part of the CGT asset retained. If the market value of the remaining part of the CGT asset has been reduced by the compulsory acquisition, any consequential effect on the cost base of the part of the asset compulsorily acquired is reflected in the apportionment formula in subsection 112-30(3) of the ITAA 1997. Once the cost base of the compulsorily acquired part of the CGT asset is worked out under subsection 112-30(3) of the ITAA 1997, the balance of the cost base of the CGT asset is attributed by subsection 112-30(4) of the ITAA 1997 to the remaining part of the asset. | Detailed Reasoning - Calculation of capital gain under section 124-85 of the ITAA 1997: As you acquired the original asset after 20 September 1985, the way rollover applies will depend on whether the money you receive is more or less than the cost of replacing the asset (subsection 124-85(2) of the ITAA 1997). The term "money" refers to the gross amount paid. If you do not use all of the money you receive to replace the original asset, this affects your CGT obligation. The amount of capital gain that is included in your tax return depends on whether the capital gain is more or less than the difference between the amount you receive and the cost of the replacement land. If the capital gain is more than that difference, the capital gain is reduced to the amount of the excess. This gain may be eligible for the CGT discount. When a later CGT event happens, the expenditure to include in the cost base of the asset is reduced by the difference between the gain before it is reduced and the excess. This enables you to defer part of your CGT liability until a later CGT event happens.

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