Principles of Taxation Law: Income Tax and CGT Implications, Legal Advice on Tax Deductibility

PRINCIPLES OF TAXATION LAW
STUDENT ID:
[Pick the date]

Question 1
On the basis of the given information, the key issue is to highlight the income tax and CGT
implications in relation to the inherited property left by Joe (Father) for Tony & Hub (Both
sons).
Case 1: The property continues to be as rent and no change
It is apparent that rent income has been received by the brothers to the tune of $ 12,000 and
this would be assessable income as per s. 6(5) (Reuters, 2017). Since both the brothers have
ownership on the property, hence the division of rent income between the two would be in
proportion to the ownership share from inheritance.
It is noteworthy that inheritance is not categorised as a CGT event even through it leads to
change in ownership but the asset has not been sold. Hence, the CGT consequences for the
given property would arise if the property is liquidated. The levying of CGT would be
contingent on a host of factors particularly time (Woellner, 2014).
Case 2: The house is liquidated and the proceeds diverted to other investments
In the context of dwellings that are inherited, there may arise a case where the residence or
asset has been purchased before September 20, 1985 (pre-CGT era) but the purchaser tends to
die after CGT comes into place. In accordance with s. 118-195, such assets would not be
levied any CGT provided the inherited asset from the deceased is liquidated within two years
from the time of death. Also, it is noteworthy that the above clause is independent of the
usage of the property during the two years (Kreyer, 2017). Thus, even if it is used for income
generation, then also CGT exemption would be available. For the situation at hand, Joe did
build house on the land in the pre CGT era but expired after CGT was in place. Thus, selling
of property on immediate basis would insulate the brothers from CGT implications
(Coleman, 2015). This is despite the fact that income generation has been done by renting the
property.
The sale proceeds would not be taxed owing to capital nature while the capital gains would
also be exempt. The investment of proceeds in other assets is not of relevance for the given
case (Barkoczy, 2017).
Case 3: Stripping of existing house and erection of new house

The first aspect that is noteworthy here is that there is improvement and not repairs in the
existing house since there is significant improvement which makes the house look like new.
This is important since s. 25-10 provides deduction for repairs of rental property. However, in
accordance with verdict in FCT v Western Suburbs Cinemas Ltd (1952) HCA 28, the expense
of $ 200,000 would be considered as capital improvement and thus out of the domain of s.8-1
owing to negative limb prohibiting deduction for capital outgoings (Gliders,et. al., 2014).
Thus, the net effect of the construction of new house and improvement in the old house
would be an increase in the cost base of the given property as per s. 110-25 since one of the
components of cost base is any capital expenditure which tends to enhance the value of the
underlying asset (Wilmot, 2014).
Case 4.1: Asset division and liquidation
The title of the two houses is being separated and the two would be liquidated. It is
noteworthy that even though the property is inherited and hence free but the market value of
the property at time of Joe’s death would be considered as acquisition cost (Kreyer, 2017).
Property acquisition cost = $ 1,000,000
Property improvement cost = $ 450,000
Total cost base (s. 110-25) = $1,000,000 + $ 450,000 = $ 1,450,000
Money generated from selling the two houses = $ 1,200,000*2 = $ 2,400,000
Gross capital gains from the transaction = $2,400,000 - $ 1,450,000 = $ 950,000
50% exemption under division 115 can be available which would reduce the taxable capital
gains to $ 475,000.
Case 4.2: Use the house for rent and then sell five years later
Till the time the houses are sold, the brothers would continue to have assessable income in
the form of rent. However, capital gains would arise when there is liquidation.
Total cost base (s. 110-25) = $1,000,000 + $ 450,000 = $ 1,450,000
Money generated from selling the two houses = $ 2,400,000*2 = $ 4,800,000
Gross capital gains from the transaction = $4,800,000 - $ 1,450,000 = $ 3, 350,000