Private ruling: Capital Gains Tax and rental property obligations
Date of advice: 15 June 2017
Published: October 2017
Ruling period: Year ending 30 June 2017 | Year ending 30 June 2018 | Year ending 30 June 2019
Date scheme commenced: 1 July 2016

Ruling: Q1: Are the costs incurred in purchasing the rental properties (including the property price and related costs such as stamp duty on the transfer of property title) part of the cost base? | A1: Yes | Q2: Are the development costs incurred in relation to the rental properties (such as development application fee, consultation, plumbing, building work, survey, and Land and Properties fee) deductible in the financial year in which they are incurred? | A2: No. They will form part of the cost base. | Q3: Are you entitled to claim a deduction for a portion of the borrowing costs incurred in the purchase of the rental properties? | A3: Yes | Q4: Are you entitled to claim a deduction for the stamp duty charged on the mortgage of the rental properties? | A4: Yes | Q5: Are you entitled to a 50% discount for your CGT liability on the sale of your two rental properties after you hold the properties for 12 months? | A5: Yes | Q6: Are you entitled to claim depreciation for the two properties that you keep for long term investment? | A6: Yes

Relevant facts and circumstances: You purchased a property subject to existing tenancy. The property was settled in the 2016-17 financial year. The property is a block of X residential units on one title. All X units were rented on contract date and settlement date. You lodged a development application to separate the X units into X strata titles so that the units can be sold separately. There will be no substantial renovation works being carried out. Plumbing work will be carried out as per the development application conditions. Some minor repairs will be carried out to the units. Once the strata titling process is finalised, the entity intends to sell one unit and keep the other X units as long term investments. You do not do any other business, or hold any other investments other than those listed above.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 Subdivision 110-A | Income Tax Assessment Act 1997 Section 112-25

Reasons for decision: Detailed Reasoning - Capital Gains Tax – Cost base: You make a capital gain or a capital loss as a result of a CGT event happening. The most common CGT event is CGT event A1 which occurs when your ownership interest in a CGT asset is disposed of to another entity. For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your asset. Subdivision 110-A of the ITAA 1997 that the cost base of a CGT asset consists of the following five elements: ● the first element of the cost base is the total of the acquisition costs, being the total of the money paid, or required to be paid, and the market value of the property given, in respect of the acquisition; ● the second element of the cost base is the incidental costs that the taxpayer incurs in acquiring and disposing the asset of which relate to a CGT event that happens in relation to the asset. The following are incidental costs that can be included in the second element of the cost base: ● remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal advisor ● the costs of transfer ● stamp duty ● the cost of advertising or marketing to find a buyer or seller ● search fees relating to a CGT asset ● costs relating to making a valuation or apportionment ● the cost of a conveyancing kit, or similar cost, and ● borrowing expenses, such as loan application fees and mortgage discharge fees. ● the third element of the cost base of an asset acquired after 20 August 1991 is the non-capital costs of ownership. These costs include interest on money borrowed to acquire the asset or to refinance such a borrowing, interest on money borrowed to finance capital improvements to the asset, repairs and maintenance, insurance premiums, rates and land tax; ● the fourth element of the cost base is capital expenditure you incurred to increase or preserve the asset’s value, or that relates to installing or moving the asset; and ● the fifth element is capital expenditure that you incurred to establish, preserve or defend your title to the asset, or a right over the asset. Purchase price The initial expense of the purchase price will form part of the first element the cost base being the total of the money paid, or required to be paid, and the market value of the property given, in respect of the acquisition. The initial expenses incurred for stamp duty and borrowing expenses when purchasing your property are considered to be capital expenses and will form part of the second element of the property’s cost base. Development costs The fourth element is capital costs you incurred for the purpose or the expected effect of increasing or preserving the asset’s value – for example, costs incurred in applying (successfully or unsuccessfully) for zoning changes. The rental property is a CGT asset. The development application and other work was undertaken with the intention of developing your rental property into X separate units. This expenditure is seen as potentially increasing the value of the property as there would be X units which could be rented to produce assessable income. Strata title established – splitting of asset Section 112-25 of the ITAA 1997 sets out the CGT rules for splitting a CGT asset. The split itself is not a CGT event. If an original land parcel is split into two or more blocks, and beneficial ownership of the original land parcel and each of the new blocks is retained, section 112-25 provides that each element of the cost base of the original asset (worked out at the time of the split) is apportioned in a reasonable way and included in the corresponding element of the cost base of each new asset. | Detailed Reasoning - Borrowing expenses: You can claim a deduction for borrowing expenses associated with purchasing your property, such as loan establishment fees, title search fees, and costs of preparing and filing mortgage documents. (Interest on the loan is not a borrowing expense, and can be claimed immediately.) If your total borrowing expenses are more than $100, the deduction is spread over five years or the term of the loan, whichever is less. If the total borrowing expenses are $100 or less, you can claim a full deduction in the income year they are incurred. What can you claim? You can claim all of the following as borrowing expenses: ● stamp duty charged on the mortgage ● loan establishment fees ● title search fees charged by your lender ● costs (including solicitors' fees) for preparing and filing mortgage documents ● mortgage broker fees ● fees for a valuation required for loan approval ● lender's mortgage insurance, which is insurance taken out by the lender and billed to you. What are you unable to claim? You cannot claim any of the following as borrowing expenses: ● stamp duty charged by your state/territory government on the transfer (purchase) of the property title ● legal expenses including solicitors' fees for the purchase of the property (these are capital expenses) ● stamp duty you incur when you acquire a leasehold interest in property such as an Australian Capital Territory 99-year crown lease (you may be able to claim this as a lease document expense) ● insurance premiums where, under the policy, your loan will be paid out in the event that you die, become disabled or unemployed (this is a private expense) ● borrowing expenses on any portion of the loan you use for private purposes (for example, money you use to invest in a super fund). Stamp duty and legal expenses may be included in calculating the 'cost base' of the property for capital gains tax (CGT) purposes as they are capital expenses. | Detailed Reasoning - Capital Gains Tax – 50% discount: You may make a capital gain or capital loss when you sell or otherwise dispose of a rental property (unless you acquired it before CGT started on 20 September 1985). You can also make a capital gain or capital loss from some capital improvements made since that date to a property you acquired previously. You make a capital gain from the sale of your rental property to the extent that the capital proceeds you receive are more than the cost base of the property. You make a capital loss to the extent that the property’s reduced cost base exceeds those capital proceeds. If you're a co-owner of an investment property, you'll make a capital gain or capital loss in accordance with your interest in the property. The cost base and reduced cost base of a property includes the amount you paid for it together with some incidental costs associated with acquiring, holding and disposing of it (such as legal fees, stamp duty and real estate agent’s commissions). Amounts that you've claimed as a tax deduction or that you can claim are excluded from the property’s cost base or reduced cost base. The discount method of applying your capital gain You can use the discount method to calculate your capital gain if: ● you are an individual, a trust or a complying superannuation entity ● a capital gains tax (CGT) event happens to an asset you own ● the CGT event happened after September 199X ● you acquired the asset at least 12 months before the CGT event ● you did not choose to use the indexation method. Generally, the discount method does not apply to companies, although it can apply to a limited number of capital gains made by life insurance companies. In determining whether you acquired the CGT asset at least 12 months before the CGT event, you exclude both the day of acquisition and the day of the CGT event. You can use the discount method to work out your capital gain from the property if: ● you acquire a property and construct a building or make improvements to it that are not separate assets ● you owned the property for at least 12 months (even if you did not construct the new building or improvements more than 12 months before the CGT event happened). In your case, if you dispose of the rental properties, after holding the properties for more than 12 months, you will be eligible for the discount method. | Detailed Reasoning - Depreciation: You can claim a deduction for the decline in value of certain items, known as depreciating assets, that you acquired as part of the purchase of your property or that you subsequently purchased for your property. A depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. Examples of depreciating assets are freestanding furniture, stoves, washing machines and television sets. The decline in value of a depreciating asset starts when you first use it, or install it ready for use. This is known as the depreciating asset's start time. For example, if you purchased an asset on 1 January (and used it only for a taxable purpose), you can claim half of the first income year's decline in value. Your deduction is reduced to the extent your use of the asset is for other than a taxable purpose. For assets costing $300 or less, you can claim an immediate deduction for the entire cost (to the extent you use it for a taxable purpose). You can't do this if the asset is one of a set of assets that together cost more than $300 – for example, if you buy four dining chairs each costing $250, you can't treat them as separate assets to claim an immediate deduction. To work out the decline in value of a depreciating asset, you need to know its effective life – that is, how many years you can use it for a taxable purpose. For most depreciating assets, you can work out the effective life yourself, or use an effective life determined by us. To work out your deduction for depreciation, use either the: ● prime cost method – this means the value of the depreciating asset decreases uniformly over its effective life, or ● diminishing cost method – this means the decline in value each year is a constant proportion of the remaining value; so it diminishes over time.