Private ruling: Capital gains tax
Published: September 2017
Ruling period: Year ended 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Will a capital gain or capital loss arise from the demolition of the original dwelling? | A1: No. | Q2: Are you entitled to the main residence exemption when you have demolished the dwelling and are selling vacant land? | A2: No. | Q3: Would the first element of the cost base of vacant subdivided land be determined using the market value of the property the date it was first used to produce income? | A3: No.

Relevant facts and circumstances: You purchased a property after 25 September 1985 that was your main residence. You moved into the property directly after it was purchased. After 20 August 1996 you moved to another property (which became your nominated main residence) and commenced renting the previous house to the current date. You may opt to demolish the house on the previous property and subsequently subdivide the land and sell off. You will not receive any capital proceeds when you demolish the house.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 118-192

Reasons for decision: Detailed Reasoning - Demolition of dwelling: Capital gains tax (CGT) event C1 will happen when you demolished the existing dwelling. As no consideration will be received for the demolition of the dwelling, no cost base is attributed to the dwelling (subsections 112.-30(2), 112-30(3) and 112-30(4) of the Income Tax Assessment Act 1997 (ITAA 1997)). This means that there will be no capital gain or capital loss made on demolition of the dwelling. The original purchase price of the dwelling and land will be attributed to the land. | Detailed Reasoning - Main residence exemption: A capital gain or capital loss an individual makes from a CGT event that happens to a dwelling is disregarded under section 118-110 of the ITAA 1997 if the dwelling was the your residence for the entire period you owned it. Section 118-120 of the ITAA 1997 extends the application of the main residence exemption to the dwelling's adjacent land (up to 2 hectares). However section 118-165 of the ITAA 1997 provides that the main residence exemption does not apply to a CGT event that happens in relation to land, to which the exemption can extend under section 118-120 of the ITAA 1997, if that CGT event does not also happen to the dwelling. CGT event A1 will occur when the vacant land is sold, but this CGT event will not happen to the dwelling. CGT event C1 (about loss or destruction) will have already happened to the dwelling when it was demolished. Therefore, section 118-165 of the ITAA 1997 applies to deny a main residence exemption on the capital gain made on the disposal of the land. | Detailed Reasoning - Home first used to produce income: If you start using your main residence to produce income for the first time after 20 August 1996, a special rule affects the way you calculate your capital gain or capital loss. In working out the amount of capital gain or capital loss, the period before the dwelling is first use to produce income is not taken into account. Section 118-192 of the ITAA 1997 provides that you are taken to have acquired the dwelling at the time you first started using it for income producing purposes for its market value at that time if all of the following apply: ● you acquired the dwelling on or after 20 September 1985 (post CGT) ● you first used the dwelling to produce income after 20 August 1996 ● when a CGT event happens in relation to the dwelling, you would obtain only a part exemption because the dwelling was used to produce assessable income during the period you owned it, and ● you would have been entitled to a full exemption if the CGT event happened to the dwelling immediately before you first used it to produce income. This has the effect that the first element of the dwelling's cost base and reduced cost base is the market value of the dwelling on the day it was first used for income producing purposes (and that expenditure incurred by the taxpayer prior to that day is ignored). In your case, you would not be entitled to a partial exemption when CGT event A1 happens to the vacant subdivided land because the main residence exemption attaches to the property and not the land. As you will have demolished the property and will be selling vacant land there is no dwelling to claim the exemption against. Consequently the home first used to produce income rule will not apply and you cannot use the market value of the property on the date it was first used for income producing purposes for the purpose of calculating your capital gain or loss. Therefore, you will need to use the relevant portion (discussed below) of the original purchase price of the property (both the land and the dwelling) when calculating your capital gain or loss on the sale of vacant subdivided land. | Detailed Reasoning - Subdivision of land: The subdivision of land itself does not constitute a CGT event as there is no change of ownership. It is at the time of the disposal that any capital gain or capital loss may arise. Where a property that was acquired as one asset is subdivided, the new assets are treated as though they were always separate assets. Therefore, the subdivided blocks will retain the acquisition date of the original property. The cost base of the original property will be apportioned between the subdivided blocks on a reasonable basis. Taxation Determination TD 97/3 provides that the Commissioner will accept any reasonable method of apportioning the original cost base between the new blocks (that is, on an area basis or relative market value basis). A reasonable apportionment of the original cost of the land itself can usually be achieved on an area basis if all the land is of similar size and market value or on a relative market value basis if this is not the case. Costs such as survey, legal fees and application fees should be apportioned in accordance with the methodology used to apportion the cost base of the land. However, costs which relate solely to a particular lot (such as connection of electricity, water and construction costs) are attributable solely to the lot to which those costs relate.