Private ruling: Cost bases and deductions
Published: September 2011
Ruling period: Year ended 30 June 2010
Date scheme commenced: 1 July 2007

Ruling: Question and answer | Is there an increase in the cost base of a rental property which is refinanced to pay for a divorce settlement? | No | Is the interest on the increased borrowings against your rental property which were used to pay for a divorce settlement deductible? | No

Relevant facts and circumstances: You entered into a negotiate property settlement with your former spouse. You have a rental property You secured additional borrowings on your rental property to pay for the property settlement

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 25-25 | Section 110-25 | Section 110-55

Reasons for decision: Detailed Reasoning - Cost base: The cost base and reduced cost base of an asset each consist of five elements (sections 110-25 and 110-55 of the ITAA 1997). The elements of the reduced cost base of a CGT asset are the same as those for cost base except for the third element (subsection 110-55(2) of the ITAA 1997). | Detailed Reasoning - First element: The first element of cost base and reduced cost base is the total of the money paid, or required to be paid, and the market value of property given, or required to be given, in respect of the acquisition of the asset (subsection 110-25(2) of the ITAA 1997). In the context of subsection 110-25(2) of the ITAA 1997, regard must be had to the presence of other elements of cost base. In particular, the specific inclusion of incidental costs of acquisition in the second element of cost base indicates that 'incidentals' would not ordinarily be included in the first element of cost base. Accordingly, the additional borrowing were not incurred in respect of acquiring the property as you were the existing owner. | Detailed Reasoning - Second element: The second element of cost base and reduced cost base is the incidental costs that the taxpayer incurs in acquiring the CGT asset or which relate to a CGT event that happens in relation to the CGT asset (subsection 110-25(3) of the ITAA 1997). Section 110-35 of the ITAA 1997 sets out the types of incidental costs. Second element costs are typically costs which facilitate the acquisition of a CGT asset. One of these types of incidental costs is stamp duty or other similar duty. These amounts can not be applied to the cost base where you are entitled to a taxation deduction for them. Additional borrowings were incurred to support the transfer of the property as you were the existing owner. | Detailed Reasoning - Third element: The third element of cost base is the non-capital costs of ownership (subsection 110-25(4) of the ITAA 1997). These costs include: · Interest on money borrowed to acquire an asset; and · Costs of maintaining, repairing or insuring it; and · Rates or land tax, if the asset is land; and · Interest on money you borrowed to refinance the money you borrowed to acquire the asset These amounts can not be applied to the cost base where you are entitled to a taxation deduction for them. You additional borrowings are non-capital costs as you were the existing owner of the property; you did not borrow to acquire the asset. | Detailed Reasoning - Fourth element: The fourth element of cost base and reduced cost base is capital expenditure incurred to increase the asset's value and which is reflected in the state or nature of the asset at the time of the CGT event (subsection 110-25(5) of the ITAA 1997). You have not specifically attributed an expense or category of expense which attributed to an increase in the asset's value. None of your expenses fall under the fourth element. | Detailed Reasoning - Fifth element: The fifth element of cost base or reduced cost base is capital expenditure incurred to establish, preserve or defend the title to the asset, or a right over the asset (subsection 110-25(6) of the ITAA 1997). Your title did not come under dispute. The money paid to your former spouse was not a sum paid to defend your title possession. | Detailed Reasoning - Conclusion: The cost base of the CGT asset remains unchanged as you were the existing sole title holder prior to increasing your borrowings with no change to your level of ownership after the borrowings. | Detailed Reasoning - Interest expenses: Interest expenses are deductible to the extent that the borrowed moneys are used for the purpose of producing assessable income (section 25-25 of the ITAA 1997). The interest on a loan taken out on the security of a rental property is not deductible where the objective purpose of the borrowing was not for the production of income but for a private purpose. Therefore, increased interest expenses corresponding to the acquisition of an income producing asset is deductible. As you increased your borrowings to reach a settlement with your former spouse, this outgoing is not of an income producing nature and is therefore not deductible.

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