Private ruling: Capital gains tax - deceased estate - main residence exemption
Published: August 2014
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Will you be able to disregard any capital gain or capital loss made on the disposal of the dwelling? | A1: No. | Q2: Will your cost base include the amount paid to the life tenant for acquisition of their ownership interest? | A2: Yes.

Relevant facts and circumstances: The property was owned by your parent who purchased it prior to the introduction of capital gains tax (CGT). The property was the main residence of your parent at all times up until their death after 20 September 1985. Your parent's Will left a life interest in the property to the spouse with the remainder beneficiaries being the children in equal portions. You are one of the remainder beneficiaries. The Will did not contain any right of sale or demolition in relation to the existing dwelling, nor did it consent to the arrangement of a replacement dwelling for the life interest to reside in. The property consisted of a single house on the land. The deceased's spouse (the spouse) and the remaindermen all agreed that the house be demolished and units be erected. The spouse would continue to live in unit 1 under the life interest. The original house and land was considered difficult for the spouse to maintain and excess to requirements, this subdividing and converting to units, X of which would be rented out, was deemed a good solution. The house was subsequently demolished, land subdivided into equal blocks and the units constructed. The spouse did not own another property as a main residence during the period of demolition and construction of the new property. On completion the spouse moved into the new property. The title of the new property remained in the same names as the original property, being the remainder beneficiaries, with a life interest for the spouse. The spouse lived in the new property for several years until it was sold. The spouse was paid an amount for their life interest, as determined by actuary, with the remainder beneficiaries receiving equal portions. The new property was not used for income producing purposes.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 102-20 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Subsection 104-20(1) | Income Tax Assessment Act 1997 Division 110 | Income Tax Assessment Act 1997 Subsection 112-30(2) | Income Tax Assessment Act 1997 Subsection 112-30(3) | Income Tax Assessment Act 1997 Subsection 112-30(4) | Income Tax Assessment Act 1997 Subdivision 118-B | Income Tax Assessment Act 1997 Section 118-195 | Income Tax Assessment Act 1997 Section 118-200 | Income Tax Assessment Act 1997 Section 118-210 | Income Tax Assessment Act 1997 Section 128-20

Reasons for decision: Summary: All references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise specified. | Detailed Reasoning - Capital gains tax: Section 102-20 advises that capital gains tax (CGT) is incurred when a CGT event takes place and either a capital gain or a capital loss results. Any capital gain is added to any other assessable income for the relevant year and is then taxed at the appropriate marginal tax rate. A capital loss can be offset against other current year capital gains or carried forward indefinitely to be offset against future year capital gains. The most common CGT event is known as CGT event A1 and generally occurs whenever there is a change in ownership of a CGT asset from one party to another. | Detailed Reasoning - CGT and deceased estates: Section 128-20 explains that where a taxpayer dies, there are no CGT implications where an asset passes to the legal personal representative or beneficiary, but CGT may apply when that asset is subsequently disposed of. Assets forming part of the deceased estate are deemed to have been acquired by the representative or beneficiary at the date of death of the deceased. This is so, even if there is provision for a life tenant and the asset is not immediately accessible to the beneficiary. You therefore acquired your ownership interest in the property on the date of your parent's death. Subdivision 118-B contains the rules for situations where capital gains and losses can be disregarded for main residence dwellings. Section 118-195 explains that where a dwelling passes to you as trustee or beneficiary of a deceased estate and the deceased acquired the dwelling before 20 September 1985, any capital gain or capital loss made upon its disposal is disregarded as long as: • the property is sold within 2 years of the deceased's death, or within a longer period allowed by the Commissioner; or • the dwelling was, from the deceased's death until your ownership interest ends, the main residence of one or more of: • the spouse of the deceased immediately before the death (except a spouse who was living permanently separately and apart from the deceased); or • an individual who had a right to occupy the dwelling under the deceased's will; or • if the CGT event was brought about by the individual to whom the ownership interest passed as a beneficiary - that individual. When the deceased passed away a testamentary trust was created over the dwelling as the spouse was given a life tenancy for their lifetime, thereafter to pass to the remainder beneficiaries (remaindermen). Taxation Ruling TR 2006/14 Income tax: capital gains tax: consequences of creating life and remainder interests in property and of later events affecting those interests considers the taxation consequences of creating life and remainder interests in property and of later events affecting those interests. According to TR 2006/14 Division 128 applies to the passing of an asset from a deceased individual's legal personal representative to a beneficiary in their estate (provided the asset was owned by the deceased individual at the time of their death). The spouse and remaindermen all agreed to demolish the existing dwelling that was the deceased's main residence, subdivide the existing land into separate lots and construct a separate unit on each subdivided lot, one of which was to be the surviving spouse's replacement main residence. The replacement unit was not owned by the deceased, and according to the requirements of section 118-195, the full main residence exemption cannot apply to the new dwelling. Section 118-200 contains a partial main residence exemption that may apply in situations where the full exemption is not available under section 118-195. However, the partial exemption only applies where the dwelling was owned by the deceased before they died. As discussed above, the deceased did not have an ownership interest in the newly constructed unit and therefore the partial exemption under section 118-200 cannot apply. Section 118-210 also contains an exemption if you are the trustee of a deceased estate and you acquire an ownership interest in the dwelling under the deceased's Will. However, there was no provision in the deceased's Will that empowered you as trustee to dispose of the original dwelling and acquire a replacement dwelling. As there is no connection between your acquisition of an ownership interest in the replacement dwelling and the deceased's Will, section 118-210 of the ITAA 1997 cannot apply. There are no other exemptions or partial exemptions that will apply to any capital gain or capital loss made from the disposal of the replacement dwelling. | Detailed Reasoning - Cost base: Division 110 tells you how to work out the cost base and reduced cost base of a CGT asset. The cost base of a CGT asset is made up of five elements: First element - the money you paid or are required to pay, in respect of acquiring it or the market value of any property you gave or are required to give in respect of acquiring it. Second element - incidental costs you incurred to acquire the CGT asset or relate to a CGT event that happens in relation to the asset. Third element - non-capital costs of ownership of the CGT asset if you acquired the asset after 20 August 1991. Fourth element - capital expenditure to increase the asset's value if the expenditure is reflected in the state or nature of the asset at the time of the CGT event. Fifth element - capital expenditure you incurred to establish, preserve or defend your title to the asset or right over the asset. | Detailed Reasoning - Surrender of Life Interest: Paragraph 85 of TR 2006/14 states that bringing a legal life interest into existence involves a disposal of part of an existing CGT asset in a similar way to the disposal of a percentage interest in it. The part of the original asset that is not disposed of to the life interest owner is the legal remainder interest. In other words, when the owners of a property grant a legal life tenancy, they are effectively disposing of part of the property. This means that the cost base of the property is required to be apportioned between the legal life tenancy and the legal remainder interest in accordance with subsections 112-30(2), (3) and (4). When a life interest owner disposes their interest in a deceased estate there is a change of ownership from one party to another which triggers a CGT event A1. The surviving spouse had a life interest in the trust which they disposed of to you and your siblings. The property was sold and an amount was paid to the surviving spouse for the life interest, as determined by actuary. You and your siblings received one X of the remaining capital proceeds. Your cost base will include your share of the amount paid for acquisition of the life interest. | Detailed Reasoning - Demolition and subdivision: According to Taxation Determination TD 1999/79 Income tax: capital gains: does the expression 'lost or destroyed' for the purposes of CGT event C1 in subsection 104-20(1) of the Income Tax Assessment Act 1997 apply to:(a) a voluntary 'loss' or 'destruction'? (b) intangible assets? , CGT event C1 can happen on the voluntary destruction of an asset, where you demolish a dwelling in the course of redeveloping a property. A CGT C1 event happened when you demolished the original dwelling. You will need to apportion the cost base or reduced cost base between the land and the dwelling according to the CGT apportionment rules. You may have made a capital gain from the CGT event C1 if any capital proceeds you received from the demolition of the dwelling were greater than the cost base of that part of the CGT asset represented by the dwelling. You would have made a capital loss if the proceeds were less than the reduced cost base. If you did not receive any capital proceeds from the demolition of the dwelling, the market value substitution rule does not apply to CGT event C1. Therefore, the effect of this is that no cost base amount is apportioned to the cost base/reduced cost base of the dwelling. Subdivision itself is not a CGT event. Therefore the acquisition date of the subdivided blocks will remain the date of the deceased's death. The cost base of the land is apportioned between the subdivided blocks on a reasonable basis. Taxation Determination TD 97/3 Income tax: capital gains: if a parcel of land acquired after 19 September 1985 is subdivided into lots ('blocks'), does Part IIIA of the Income Tax Assessment Act 1936 treat a disposal of a block of the subdivided land as the disposal of part of an asset (the original land parcel) or the disposal of an asset in its own right (the subdivided block)? provides that the Commissioner will accept any reasonable method of apportioning the cost base between the new blocks, for example, on an area basis or a relative market value basis. The actual costs of subdivision should also be apportioned between the X blocks. If the blocks are of unequal market value the Commissioner considers that costs such as surveying, legal fees and application fees associated with the subdivision should be apportioned in accordance with the relative market values of each block. However, any costs solely related to one block, such as connection of water or electricity should be attributed solely to the cost of that block. Therefore the costs incurred in the construction of the unit that became the surviving spouse's main residence will form part of the cost base of the land to which it relates and should be attributed solely to that block. The building of the new unit on land already owned is an improvement to the land and it is not treated as a separate asset. On the completion of that unit it became a single post-CGT asset that comprises both the land and the building. The capital cost of building the new house is included in the fourth element of the cost base of the property. | Summary: You acquired one X of the asset on the date of death of the deceased and as the owner of one X of the property, your net capital gain or capital loss from the disposal will be one third of the total. You will include in your cost base: First element - your share of the amount paid to the surviving spouse for the life tenancy. Second element - incidental costs you incurred to acquire the CGT asset or relate to a CGT event that happens in relation to the asset. Third element - non-capital costs of ownership of the CGT asset if you acquired the asset after 20 August 1991. Fourth element - your share of the apportioned costs of demolition, subdivision and construction of the unit. Fifth element - capital expenditure you incurred to establish, preserve or defend your title to the asset or right over the asset. | Detailed Reasoning - Discount method: The discount method can be used to calculate your net capital gain when: • you are an individual; • the CGT event happened to an asset after 21 September 1999; • you owned the asset for 12 months; and • the cost base of the asset was not indexed. Where these conditions are met, your capital gain is reduced by 50%.