Private ruling: Capital gain tax liability upon disposal of an income producing dwelling and capital works deduction
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Q1: Is any capital gain or loss made upon disposal of the income producing dwelling disregarded? | A1: Yes. | Q2: Are the deductions for capital works incurred in constructing the replacement dwelling an allowable deduction under Division 43 of the Income Tax Assessment Act 1997 ? | A2: Yes.

Relevant facts and circumstances: A dwelling was purchased as joint tenants prior to 20 September 1985 as a principle place of residence. The dwelling was used for income producing purposes and was rented out for many years. The dwelling was destroyed by a natural disaster. You did not make an election under Section 160ZZK of the Income Tax Assessment Act 1936 at the time you lodged your income tax return in the year the event occurred. You requested that the Commissioner grant you further time to make the election. The destruction of your dwelling as a result of a natural disaster traumatised you. You have had the same tax agent for many years and were not made aware of the requirement to make a written election at the time of lodging your income tax return. Over the last few years, your spouse's health has deteriorated resulting in lengthy periods in hospital with continuous professional care required in your home. The Commissioner exercised his discretion and granted you further time to make the election in relation to your 50% ownership interest in the rental property. The dwelling was re-built with construction completed in the same year. The dwelling was used for income producing purposes a month after construction was completed until the present time. For the purpose of this ruling, the dwelling will be sold in this income year. You have incurred capital works to replace the dwelling destroyed by a natural disaster.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 160ZZK, | Income Tax Assessment Act 1997 subs ection 108-55(2), | Income Tax Assessment Act 1997 Section 104-10, | Income Tax Assessment Act 1997 Section 43-10, | Income Tax Assessment Act 1997 Section 43-15, | Income Tax Assessment Act 1997 Section 43-20, | Income Tax Assessment Act 1997 Section 43-25, | Income Tax Assessment Act 1997 Section 43-30, | Income Tax Assessment Act 1997 Section 43-70, and | Income Tax Assessment Act 1997 Section 43-210.

Reasons for decision: Detailed Reasoning - Building a separate asset from land?: A building or structure that is constructed on land that you acquired before 20 September 1985 is taken to be a separate capital gains tax (CGT) asset from the land if: (a) you entered into a contract for the construction on or after that day; or (b) if there is no contract, the construction started on or after that day. In your circumstances, you purchased the original dwelling and land prior to 20 September 1985. The dwelling was destroyed by a natural disaster. Construction of a replacement dwelling was completed in the same year as the dwelling was destroyed by a natural disaster and was rented within a month of construction being completed. The dwelling is considered to be a separate CGT asset from the land acquired prior to 20 September 1985. However, the Commissioner allows for roll-over relief in certain circumstances which affects how the CGT asset is viewed. | Detailed Reasoning - Roll-over relief: When there is an involuntary disposal of an asset as a result of a natural disaster, such as a bushfire, there is provision for roll-over relief in respect of compensation received and where an asset is received as a result of an involuntary disposal of an asset. If the taxpayer has received compensation for the involuntary disposal of the rental property then roll-over relief may be available. For roll-over relief to apply the taxpayer must: · dispose of the asset and receive cash compensation by reason of the compulsory acquisition of the asset or for the loss or destruction of, or damage to, the asset. not earlier than one year before the disposal took place and not later than one year after the end of the year of income in which the disposal took place the taxpayer incurred expenditure in acquiring a replacement asset in place of the original asset or incurred expenditure of a capital nature in repairing or restoring the original asset. · the replacement asset is not trading stock of the taxpayer immediately after its acquisition by the taxpayer. · if the original asset was owned by a non-resident taxpayer and the asset is a taxable Australian asset, then the replacement asset is also a taxable Australian asset. · the taxpayer has lodged an election, electing that this section apply in respect to the disposal of the original asset. In your circumstances, your original dwelling was purchased prior to 20 September 1985. As it was acquired before 20 September 1985 the dwelling is a pre-CGT asset. You used the dwelling for income producing purposes for many years until the dwelling was destroyed by a natural disaster. You chose to construct a new dwelling which was completed after 20 September 1985. You used this dwelling for income producing purposes within month after construction was completed and it continues to be an income producing asset. You requested the Commissioner grant your further time to make the Section 160ZZK election. As the Commissioner has granted your request, you are deemed to have made a written election notifying the Commissioner that you have chosen to apply roll-over in relation to the disposal. In making the election and acquiring a replacement asset, being a rental property, you met the conditions required for a replacement asset and you are entitled to apply the roll-over. In addition, the land and the dwelling will be deemed one asset. The replacement dwelling will have an acquisition date of the original dwelling. Upon disposal of the dwelling you may disregard any capital gain or capital loss as the dwelling and land is a pre-CGT asset. | Detailed Reasoning - Question 2: Tax Ruling 97/25 (TR 97/25) Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements , explains what qualifies as capital expenditure. There are three categories of capital works: · buildings or extensions, alterations or improvements to buildings; · structural improvements or extensions, alterations or improvements to structural improvements; and · environment protection earthworks. Certain 'construction expenditure' incurred in respect of the construction of capital works provides a deduction. The building of the investment property qualifies as capital works. | Detailed Reasoning - Capital Works: TR 97/25 provides at paragraph 9 that construction expenditure includes preliminary expenses such as architect fees, engineering fees, foundation excavation expenses and costs of building permits. These expenses are accepted as being in respect of the construction of capital works. A taxpayer can claim a deduction for capital expenditure incurred in constructing a building for the purposes of producing assessable income. Capital works deductions are available on the cost of constructing buildings, or extensions alterations or improvements to such structures. A qualifying expenditure is generally of a capital nature in relation to the construction of the building or part of the building where at the time of completion of construction, the building is used, or is maintained ready for use, for income producing purposes by the person who incurs the capital expenditure. The total capital works deductions cannot exceed the construction expenditure and no deduction is available until construction is complete. Construction expenditure which cannot be claimed include: · the cost of the land on which the rental property is built; · expenditure of clearing the land prior to construction; · earthworks that are permanent, can be economically maintained and are not integral to the installation or construction of the structure; and · expenditure on landscaping. The deduction for qualifying expenditure is subject to a 25 or 40 year limitation period, depending on whether the deduction rate is 4% or 2.5%. When the relevant period (either 25 or 40 years) expires, the write-off deduction ceases to be available for the qualifying expenditure. This limitation period starts on the day on which the building was first used for any purpose after completion of construction and continues to run during periods when the deduction cannot be claimed, eg because the building is not used for income-producing purposes. In your circumstances, the dwelling re-construction was completed after 15 September 1987 and the dwelling was rented within a month of construction being completed until the present time. As the start date of construction was after 15 September 1987, the rate of capital works deduction is 2.5%. Deductions for qualifying expenditure are calculated using the following formula: Portion of your construction expenditure x Days used x 0.025 365 'Days used' is the number of days in the income year that the capital works were used in a deductible way. The write off deduction may only be claimed for the period where the building is used for the purpose of producing assessable income. If you rented the dwelling for the full financial year, a deduction of 2.5% of your expenditure for the construction is an allowable deduction. In your circumstances, capital works are an allowable deduction as long as the expenses incurred are qualifying capital expenditure. | Detailed Reasoning - Note:: As you hold an ownership interest in the dwelling as a joint tenant, any deduction included in your income tax return must be divided by 50% to reflect your legal ownership in the dwelling.

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