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If a taxpayer incurs expenditure in building a house on land they already own, and the taxpayer receives a grant under the First Home Owners Grant Scheme in connection with the construction of the house, does subsection 110-45(3) of the Income Tax Assessment Act 1997 ( ITAA 1997) require the taxpayer to exclude from the cost base of the property expenditure equal to the amount of the grant received?

Yes. Subsection 110-45(3) of the ITAA 1997 requires the taxpayer to exclude from the cost base of the property so much of the expenditure incurred as equals the amount of the grant because a grant received under the First Home Owners Grant Scheme is considered to be a recoupment of that expenditure (and because the grant is not included in the taxpayer's assessable income).

The owner of land acquired after 13 May 1997 entered into a contract for a home to be built on the land. The contract required the owner to pay a certain amount for the construction of the home.

The owner qualified for the First Home Owners Grant Scheme administered by their State Government.

When the property was eventually sold the owner was only entitled to a partial main residence exemption because part of the home was used to produce assessable income throughout the ownership period.

In working out the amount of the capital gain on sale of the property the owner questioned whether the grant received under the First Home Owners Grant Scheme was taken into account in calculating the property's cost base.

The owner's expenditure to build the home falls under the fourth element of the cost base of the land. It is expenditure the owner incurred to increase the land's value (subsection 110-25(5) of the ITAA 1997).

However, subsection 110-45(3) of the ITAA 1997 provides that expenditure does not form part of any element of the cost base to the extent of any amount you have received as recoupment of it, except so far as the amount is included in your assessable income.

Recoupment is defined in section 20-25 of the ITAA 1997 to include a grant in respect of a loss or outgoing.

A grant received under the First Home Owners Grant Scheme is considered to be in respect of the outgoing incurred to build the owner's home and is thus, to the extent of the amount of the grant, a recoupment of that expenditure for the purposes of subsection 110-45(3) of the ITAA 1997.

As a grant received under the First Home Owners Grant Scheme is not ordinary income (see ATO ID 2001/715) and is not statutory income in the recipient's hands, no amount in respect of it is included in the recipient's assessable income.

Therefore, expenditure to build the home does not form part of any element of the cost base of the land to the extent of the amount of the grant.