Private ruling: Capital gains tax and the sale of vacant land
Ruling period: Year ending 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Questions and answers | Is the vacant block of land a capital gains tax (CGT) asset? | Yes. | Will the proceeds from the sale of the land be considered to be profits from an isolated transaction and assessable income under 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | No. | Will a CGT event happen at the time you enter into a contract for the sale of the block of land? | Yes. | Are you entitled to claim a deduction for the interest expenses incurred during the period in which you intended to construct an investment property on the land? | Yes. | Are you entitled to claim a deduction for the interest expenses incurred after your intention to construct an investment property on the land ceased? | No. | Are you able to include the interest expenses that you incurred, after your intention to construct an investment property on the land ceased, in the third element of the assets cost base? | Yes.

Relevant facts and circumstances: You signed a contract for the purchase of a block of land some time after 20 September 1985. You paid a deposit at the time of signing the contract with the balance becoming payable some time later. It was your intention to build a dwelling on the land within twelve months of its purchase. You intended to rent the dwelling out. Your builder prepared and drew up plans in respect of the intended dwelling. This is the only action that has been taken in respect of the vacant block of land. You have not erected any fences or any other structure on the land. Due to interest rate rises and concerns regarding potential financial pressures on you and your family, you decided to cease any building plans and sell the vacant block of land. You intend to sell the block of land about two years after you acquired it. You will make a capital gain on the sale. You have incurred interest expenses in respect of the block of land. You have not previously purchased or sold any other land.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 6-5, | Income Tax Assessment Act 1997 Section 8-1, | Income Tax Assessment Act 1997 Section 104-10, | Income Tax Assessment Act 1997 Section 108-5 and | Income Tax Assessment Act 1997 Subsection 110-25(4)

Reasons for decision: Detailed Reasoning - CGT asset: Section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a capital gains tax (CGT) asset is any kind of property or a legal or equitable right that is not property. CGT assets include land. | Detailed Reasoning - Isolated transaction: Occasionally, land that a taxpayer disposes of may generate income that is assessable under section 6-5 of the ITAA 1997. This occurs only where the taxpayer's activities and reason for holding the land constitute the carrying on or carrying out of a profit making undertaking or plan. Taxation Ruling TR 92/3 considers profits on isolated transactions. Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction will generally be income when both the following elements are present; · the intention or purpose of a taxpayer in entering into the transaction was to make a profit or a gain, and · the transaction was entered into, and the profit was made, in the course of carrying on a business operation or commercial transaction. In determining whether an isolated transaction amounts to a business operation or commercial transaction, paragraph 13 of TR 92/3 outlines a number of factors which must be considered, including: · the nature of the entity undertaking the operation or transaction, · the nature and scale of other activities undertaken by the taxpayer, · the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained, · the nature, scale and complexity of the operation or transaction, · the manner in which the operation or transaction was entered into or carried out, · the nature or any connection between the relevant taxpayer and any other party to the operation or transaction, · if the transaction involves the acquisition and disposal of property, the nature of that property, and · the timing of the transaction or the various steps in the transaction. In your situation, the ownership and subsequent sale of the vacant block of land does not have the character of a business operation or commercial transaction. You simply purchased a vacant block of land on which you intended to construct a rental property for investment purposes. Accordingly, the sale of the land is a mere realisation of a CGT asset and any gain or loss made on the sale will be subject to the CGT provisions of the ITAA 1997. | Detailed Reasoning - Contract date or settlement date: CGT event A1 will occur when you sell the vacant block of land. The timing of the event will determine the income year in which you will be required to include your capital gain or capital loss in your income tax return. Section 104-10 of the ITAA 1997 provides that CGT event A1 happens when you enter into the contract of sale, or if there is no contract, when a change of ownership occurs. Therefore any capital gain or capital loss that you make on the sale of the vacant block of land will need to be included in your income tax return in the income year in which you enter into the contract for its sale. | Detailed Reasoning - Interest expenses: Section 8-1 of the ITAA 1997 provides that a deduction is allowable for expenses incurred in gaining or producing assessable income, provided those expenses are not capital, private or domestic in nature. In Steele v. FC of T (1999) 197 CLR 459;99 ATC 4242; (1999) 41 ATR 139, the High Court considered the deductibility of interest expenses on borrowings to purchase land intended to be developed for income production. Taxation Ruling TR 2004/4, in considering the above decision, concludes that interest incurred in a period prior to the derivation of relevant assessable income will be incurred in gaining or producing the assessable income in the following circumstances: · the interest is not incurred "too soon", is not preliminary to the income earning activities and is not a prelude to those activities; · the interest is not private or domestic; · the period of interest outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income earning activities involved, that the necessary connection between outgoings and assessable income is lost; · the interest is incurred with one end in view, the gaining or producing of assessable income; and · continuing efforts are undertaken in pursuit of that end. In your case, you borrowed funds to purchase vacant land with the intention to construct a dwelling for income producing purposes. You have no private or domestic purpose for holding the land. You engaged the service of a builder who drew up plans for the dwelling. However, you have decided that, due to increasing interest rates and potential financial pressures on you and your family, you are not continuing your efforts to pursue the construction of the dwelling and are selling the vacant block of land. The interest incurred on the borrowed funds is not considered to be preliminary or to be incurred too soon before the commencement of the income producing activity. The period of time between you purchasing the land and engaging the services of a builder to draw up plans in respect of the income producing activity is not considered to be so long that the necessary connection between the interest and the assessable income is lost. The interest was incurred with your sole intention being to construct a dwelling to use as a rental property. You continued with your effort to pursue this intention up until you made the decision, based on financial concerns, to cease plans for construction of the dwelling and sell the vacant block of land. Therefore, you are entitled to a deduction for the interest expenses that you incurred from the time you purchased the block of land until the time your plans changed from actively pursuing the construction of the dwelling to leaving the block vacant and selling it. Once your plans changed and you no longer intended to use the land to produce assessable income, the interest expense that you incurred became non deductible. However, the interest expenses that you incurred after your intentions changed are able to be included in the cost base of the land in accordance with 110-25 of the ITAA 1997.

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