Private ruling: Income tax - Capital gains tax - Discount capital gains
Published: April 2015
Ruling period: Year ending 30 June 2015. | Year ending 30 June 2016. | Year ending 30 June 2017.
Date scheme commenced: 1 July 2014.

Ruling: Q1: Will the proceeds received from the sale of the subdivided properties (that are not your main residence) be considered ordinary assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Will the proceeds received from the sale of subdivided properties (that are not your main residence) be taxed under the capital gains tax (CGT) provisions of the ITAA 1997? | A2: Yes, however any capital gain will be reduced to the extent that capital proceeds are included as assessable income under section 6-5 of the ITAA 1997. | Q3: Are you eligible for a 50% discount on CGT on the sale of the dwellings (that are not your main residence)? | A3: Yes. | Q4: Does the cost base of the property include the actual cost when you acquired the property, rather than current market value? | A4: Yes. | Q5: Does the cost base of the property include the cost of renovations two years ago? | A5: Yes.

Relevant facts and circumstances: You purchased your house and main residence several years ago. The house is on a block of less than two hectares. A tradesman recently purchased the block behind your property. The tradesman approached you to discuss the possibility of re-development because you would require easement access if you were to develop. Your options are to develop now or never. Developing now would allow you to realise the full potential value of the land. If you don't develop now, you will simply sell your property as is in the future. You now propose to demolish your current main residence, subdivide the block and construct several dwellings, one on each block. You will remain living in one as your principal place of residence and sell the other dwellings. The property is your home and will remain as such. The property has never been used to produce assessable income. The property was not purchased as a development site. This is a one-off activity. The re-development will be funded personally. The property's current value has increased significantly since you acquired it. A considerable sum was spent renovating your house recently.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5. | Income Tax Assessment Act 1997 section 110-25. | Income Tax Assessment Act 1997 section 115-10. | Income Tax Assessment Act 1997 section 118-20. | Income Tax Assessment Act 1997 section 118-110. | Income Tax Assessment Act 1997 section 118-150.

Reasons for decision: Summary: We need to determine whether the gain/profit from the sale of the land: • is assessable ordinary income under section 6-5 of the ITAA 1997 as you were carrying on a business of property development • is assessable ordinary income under section 6-5 of the ITAA 1997 as you conducted an isolated commercial transaction with a view to a profit, or • is from a mere realisation of a capital asset and only assessable under the CGT provisions of the ITAA 1997. | Detailed Reasoning - Carrying on a business of property development: Based on the information provided, we do not consider that any proceeds you would receive from the sale of the property would be derived in the course of carrying on a business. | Detailed Reasoning - Profits from an isolated transaction: Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business ( FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium). Taxation Ruling TR 92/3 considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income. If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayer's business but: • the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and • the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of land can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered: a) the nature of the entity undertaking the operation or transaction b) the nature and scale of other activities undertaken by the taxpayer c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained d) the nature, scale and complexity of the operation or transaction e) the manner in which the operation or transaction was entered into or carried out f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction g) if the transaction involves the acquisition and disposal of property, the nature of that property, and h) the timing of the transaction or the various steps in the transaction In contrast, paragraph 36 of TR 92/3 notes that the courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment. Miscellaneous Taxation Ruling MT 2006/1 provides a list of specific factors relevant to isolated transactions and sales of real property. If several of the factors are present, it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows: • there is a change of purpose for which the land is held; • additional land is acquired to be added to the original parcel of land; • the parcel of land is brought into account as a business asset; • there is a coherent plan for the subdivision of the land; • there is a business organisation - for example a manager, office and letterhead; • borrowed funds financed the acquisition or subdivision; • interest on money borrowed to defray subdivisional costs was claimed as a business expense; • there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and • buildings have been erected on the land In determining whether activities relating to isolated transactions are an enterprise or are the mere realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above; however there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative rather it will be a combination of factors that will lead to a conclusion as to the character of the activities. | Detailed Reasoning - Application to your circumstances: In this case, your property was acquired several years ago and it has been used as your main residence since. You will be demolishing your main residence, subdividing the block into several separate titles and building a dwelling on each separate title, one of which will become your main residence. We consider that you would be going above and beyond what would be required to realise the value of the land. Instead, it would appear that the project would have the characteristics of a commercial transaction. Therefore, as you will be carrying out an isolated commercial transaction with a view to a profit, the profit made will be considered ordinary assessable income under section 6-5 of the ITAA 1997. In calculating the profit from an isolated transaction involving the one-off development of land, where the land has been held for some time (for private or other purposes) before entering into the profit making transaction, the sale proceeds will be reduced by the market value of the property at the time it was ventured into the commercial transaction (that is, at the time the property ceased its previous use and instead started being held for development) and costs associated with the development. | Detailed Reasoning - Question 2: You make a capital gain or loss as a result of a CGT event happening to a CGT asset. CGT assets include real estate acquired on or after 20 September 1985. You make a capital gain if your capital proceeds from the sale of a CGT asset are greater than the cost base for the purchase of that asset, for example, if you receive more for an asset than you paid for it. You make a capital loss if your reduced cost base for the purchase of that asset is greater than the capital proceeds resulting from the sale of that asset, for example, if you receive less for an asset than you paid for it. Capital gains tax is not a separate tax, it forms part of your assessable income and is taxed at your marginal tax rate. The inclusion of the gain/profit on the sale of the property as ordinary income does not mean that a CGT event does not happen in relation to the property. However, section 118-20 of the ITAA 1997 exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. In the absence of such a provision, it is conceivable that a receipt properly characterised as ordinary income and which has also been derived as a result of a CGT event could result in the receipt being taxed twice. Therefore, whilst a CGT event will occur when the property is sold (CGT event A1), any capital gain will be disregarded to the extent of any amount already included as ordinary assessable income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Application to your circumstances: Your total capital gain when each of the dwellings (that are not your main residence) is sold (CGT event A1) may be greater than the amount of assessable income you are required to include as ordinary assessable income as outlined above in question 1. You will be liable for capital gains tax on this residual amount, after any exemptions or discounts apply. | Detailed Reasoning - 50% discount: For any capital gain you must pay tax on for the dwellings (that are not your main residence), you qualify for discount capital gains. Under section 115-10 of the ITAA 1997, to qualify for the 50% general discount a capital gain must be made by an individual, a complying superannuation entity, a trust or a life insurance company. The capital gain must result from a CGT event happening after 11:45am on 21 September 1999 and must not have an indexed cost base. Also, the gain must result from a CGT event happening to an asset that was acquired at least 12 months before the CGT event. Your acquisition date for the purposes of calculating CGT is the original date you acquired your property, which is more than 12 months before the CGT event. Accordingly, if the CGT event results in a capital gain you are entitled to apply the 50% general discount to the capital gain. | Detailed Reasoning - Demolition of dwelling: Taxation Determination TD 1999/79 confirms that a CGT event C1 can happen on the voluntary destruction of an asset where, as in your situation, you demolish a building in the course of redeveloping a property. However, a capital gain or loss does not arise at this time as you will not receive any capital proceeds from the demolition (ATO Interpretative Decision 2002/633). | Detailed Reasoning - Subdivision: When you subdivide a block of land, each block that results is registered with a separate title. For CGT purposes, the original land parcel is divided into two or more separate assets. Subdividing land does not result in a CGT event as long as the ownership of the subdivided blocks does not change. Therefore, you do not make a capital gain or capital loss at the time of subdivision. The date you acquired your interest in the subdivided blocks is the date you acquired your interest in the original land and the cost base of the original purchase is divided between the subdivided blocks on a reasonable basis. | Detailed Reasoning - Cost base: Upon disposal of a post-CGT asset, the cost base is made up of five elements: 1. The first element is made up of the money paid or required to be paid to acquire the CGT asset. 2. The second element will include incidental costs of acquiring the asset, or costs in relation to the CGT event. Examples are agent's commission, advertising to find a seller or buyer, fees paid to an accountant. 3. The third element consists of non-capital costs incurred in connection with their ownership of a CGT asset. Examples are interest, rates, repairs and insurance premiums. An individual can include non-capital costs of ownership only in the cost base of assets acquired after 21 August 1991. 4. The fourth element includes capital expenditure the individual incurs for the purpose or the expected effect of increasing or preserving the assets' value or that relates to installing or removing the asset. 5. The fifth element includes capital expenditure the individual incurs to preserve or defend their title or rights to the asset (section 110-25 of the ITAA 1997). | Detailed Reasoning - Costs of demolition: Subsection 110-25(5) of the ITAA 1997 states: The fourth element is capital expenditure you incurred: (a) the purpose or the expected effect of which is to increase or preserve the asset's value; or (b) that relates to installing or moving the asset. You intend to demolish your existing residence to make way for the subdivision of your land into several separate blocks. One will be your main residence and the others will be sold. You will be increasing the original value of your asset from one property to several separate properties. Accordingly you will be entitled to include the apportioned costs of demolition in the fourth element of the cost bases of each block. | Detailed Reasoning - Costs of subdivision: When land is subdivided, the cost base of the original asset is apportioned between the newly-created assets. Taxation Determination TD 97/3 explains that the Commissioner will accept any reasonable method of apportioning the original cost base between the new blocks. A reasonable apportionment of the cost of the land itself can usually be achieved on an area basis if all the land is of a similar size and market value or on a relative market value basis if this is not the case. For example, if one block has an uninterrupted ocean view it may be worth more than the other block that does not. The costs of subdivision should also be apportioned between the blocks. If the blocks are of unequal market value the Commissioner considers that costs such as survey, legal fees and application fees associated with the subdivision should be apportioned in accordance with relative market value of the blocks. However, any costs solely related to one block should be attributed to that block (for example, the costs of construction and costs of connecting electricity and water to the block should be attributed solely to that block). Where you are constructing a new main residence on one of the newly-created blocks, all the costs associated with that construction will be wholly attributable to that block. | Detailed Reasoning - Application to your circumstances: The cost base for each dwelling (that is not your main residence) will be calculated using the five elements outlined above and will include: • an apportionment of the cost base of your original property when it was acquired - calculated on a 'reasonable basis', plus an apportionment of the costs of your renovations, plus an apportionment of the costs of demolition; plus • an apportionment of the costs of subdividing the blocks, plus • any costs that are attributable solely to that block. | Detailed Reasoning - Question 5: For expenditure to be included in the fourth element of the cost base of an asset under subsection 110-25(5) of the ITAA 1997, it must be incurred 'to' enhance the value of the asset, that is, for the purpose of enhancing the value of an asset. It is immaterial whether or not the expenditure in fact enhances the value of the asset in accordance with ATO Interpretive Decision ATO ID 2012/46. | Detailed Reasoning - Costs of renovations: In your case, you incurred considerable costs to renovate your main residence recently. The expenditure was for the purpose of enhancing the value of the asset, even though the expenditure will not in fact enhance the value in the property, due to demolition and re-development. The costs of renovations will form part of the fourth element of your cost base. The costs of renovation will be apportioned across the subdivided properties on a 'reasonable basis'.