BUSL320 Taxation Law & Practice: CGT Liability Analysis Report

This report assesses the potential capital gains tax (CGT) liability for Jeremy and Maxine, focusing on the sale of a duplex with separate titles for each floor. The analysis considers the main residence exemption for the bottom floor and the CGT implications for the top floor, which was initially rented out. The report also examines the deductibility of various expenses related to the property and the tax treatment of collectible items (painting and Ming vase). It concludes with a recommendation regarding the CGT liability for the upper floor and the treatment of capital losses from collectibles, highlighting that these losses can only be offset against capital gains from the same asset class and will be carried forward to the next year. The report also advises that deductions for window repairs are not permissible due to the property not being rented at arm's length.

TAXATION LAW
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Introduction
The objective of the given report is to highlight the potential capital gains liability for Jeremy
and his wife Maxine taking into considering the various transactions enacted. Of significance
is the sale of duplex, which involved two floors under two different titles with the lower floor
being used as main residence while the upper floor being used a rent free residence by
Maxine’s parents. Also, in the given tax year, a painting and vase have also been sold which
also needs to be considered.
Tax Computations
I.The key objective is to determine whether the property sale would pave way to any CGT
liability or not. It is imperative to analyse this situation in the light of subdivision 118-B
ITAA 1997 which provides full exemption from Capital Gains Tax (CGT) on any capital
gains or loss derived from the sale of main residence1. As per s. 118-1102, for full exemption
it is imperative that the underlying property must continue to serve as main residence during
the complete period of ownership and must not be used for producing any assessable income.
Also, there can be only one main residence despite the taxpayer dwelling at multiple places.
In the given case, the imperative aspect is that the titles of the two floors are separate. This
implies that both the floors are considered to be separate properties from the tax perspective.
Only the bottom floor in which Jeremy and Maxine are staying is the main residence. Further,
they made the bottom floor as the main residence right from time of buying the floor and
continued to treat it as the main residence till the time of sale. Also, the bottom floor was not
used for any assessable income production. Hence, any capital gains on the bottom floor
would be considered exempt from CGT. However, the same cannot be said about the top
1 Barkoczy Stephen, Core Tax Legislation and Study Guide 2017 (Oxford University Press Australia, 2017)
2 Income Tax Assessment Act 1997

floor which was initially given on rent and later used by Maxine’s parents without paying any
rent. It is apparent that main residence exemption would not be applicable. Also, the given
property is not a pre-CGT asset and hence CGT liability would arise for the top floor.
II. The discussion regarding the various expenses is carried out below.
a) Expenses before property purchase – Deduction for expenses related to assessable income
production is permissible under s. 8-1 ITAA 1997. However, the expenses related to buying a
property which was not to be used for commercial purpose or income generation, Hence, no
deduction can be claimed in this regards3.
b) Purchase related stamp duty – It is part of the cost base of the property in accordance with
s. 110-25 ITAA 1997 and therefore a capital cost. No deduction for capital cost is permissible
under s. 8-1 ITAA 1997 irrespective of the presence of connection with assessable income4.
c) Legal expenses related to purchase - It is part of the cost base of the property in accordance
with s. 110-25 ITAA 1997 and therefore a capital cost. No deduction for capital cost is
permissible under s. 8-1 ITAA 1997 irrespective of the presence of connection with
assessable income.
Expenses d,e,f,jwould also form part of the cost base of the property and hence no deduction
for the same can be claimed as highlighted above5.
3 Krever Richard, Australian Taxation Law Cases 2017 (THOMSON LAWBOOK Company, 2017)
4 Ibid. 1
5 Ibid. 3

g) Initial repairs – Any amount of money that is spent on the various repairs before occupying
the property for the first time is referred to as initial repair. As per tax ruling TR 97/23, the
initial repairs tend to be non-deductible owing to the capital nature of the deduction.6
h) Replacing the leaking roof - The given expense would not be considered repairs since the
new material was a significant improvement over the previous material and hence the
expense is of capital nature which would not be deductible.
i) Repairs of the window- This would have been deductible under any of the two sections
namely s. 25-10 ITAA 1997 and s. 8-1 ITAA 1997 provided the property was used for
producing assessable income. However, this is not the case here and hence no deduction7.
If the property had been rented out on arm length basis, then deductions for repair of the
window would have been possible as then assessable income would have been produced from
the property.
III. The disposal of the asset triggers a A1 CGT event and hence capital gains can be
determined by finding the difference of the sales proceeds of the asset and the cost base of the
asset. As per s. 110-25(1) ITAA 1997, there are five elements of cost base as indicated below.
 Asset purchase price8
 Incidental costs incurred during buying or selling of asset9 (stamp duty, legal fees,
brokerage etc.)
 Ownership costs10 (Taxes, interest on loan)
6 Reuters, Thomson, Australian Tax Legislation (THOMSON REUTERS, 2017)
7 Ibid. 6
8 Subsection 110-25(2)
9Subsection 110-25(3)
10 Subsection 110-25(4)

 Capital costs related to preservation or improvement of asset value11
 Capital costs incurred in relation to title preservation12
It is not necessary that all the above mentioned elements would be present for a given asset
and hence the cost base would be computed based on the available elements.
Property
For the given property, the cost base would comprise of the following elements.
Element 1: Purchase price = $ 1,250,000
Element 2: Cost of property inspection = $ 1,400
Stamp duty at purchase = $ 72,000
Legal expenses on purchase = $4,300
Agent fee for sale = $13,200
Solicitor’s conveyance fee = $ 3,300
Element 3: Cost of mortgage = $ 2,700
Annual interest payment = 3100*12 = $ 37,200
Annual local taxes = $ 3,200
11 Subsection 110-25(5)
12 Subsection 110-25(6)

Element 4: Initial repairs = $18000 + 60*58 = $ 21,480
Replacement of roof = $ 73,000
Total cost base = Element 1+ Element 2 + Element 3 + Element 4 = $ 1,481,780
Sales proceeds = $1,820,000
Capital gains = 1820000 – 1481780 = $ 338,220
Collectibles
The painting and Ming vase would be considered as collectible items as highlighted in s. 118-
10 ITAA 1997.
Capital gains = Sales proceeds – Cost Base
Capital gains for painting = 8500 – 7000 = $ 1,500
Capital loss for Ming Vase = 10000-200 = $9,800
Net capital loss -= 9800 – 1500 = $ 8,300
The above cannot be adjusted against capital gains from property as the capital loss from
collectibles is adjustable only against capital gains on the same asset class. Thus, as per s.
102-5, these would be carried forward for the next year13.
IV. Capital gains for the two floors = $ 338,220
Since the lower floor would be CGT exempt on being the main residence, hence the capital
gains = (338220/2) = $ 119,110
13 Ibid. 1

Also, it is noteworthy, that the holding period of the upper floor exceeds one year and hence
the above capital gains would be long term. Hence, in accordance with s. 115-25 ITAA 1997,
50% discount would be available on the above capital gains14.
Hence, capital gains subject to CGT = 0.5*119110 = $ 59,555
CGT liability = 0.3*59,555 = $ 17,866.50
V. Recommendation/Advice
Based on the above computation, it is apparent that no CGT liability would arise for the
lower floor which is being used as main residence. However, for the upper floor, a CGT
liability of $ 59,555 would arise. For the other transactions involving painting and vase,
capital loss has arisen which would be carried forward to the next year for adjustment. Also
since the upper floor was not used for deriving rent at arms’ length, hence deduction with
regards to repairing windows would not be deductible. The other expenses are part of the cost
base of the property and hence non-adjustable against income.
14 Ibid. 6