Non-commercial losses - real property test and land adjacent to a dwelling

Does section 118-120 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to exclude only 2 hectares of land adjacent to a dwelling used mainly for private purposes from real property which can be taken into account for the purposes of the real property test in section 35-40 of the ITAA 1997?

No. For the purposes of section 35-40 of the ITAA 1997, any area of adjacent land used in association with the dwelling that is used mainly for private purposes is excluded from property which can be taken into account under the real property test. Section 118-120 of the ITAA 1997 does not limit the application of section 35-40 of the ITAA 1997.

The taxpayer carries on a business activity of mixed farming on 10 hectares of land which he owns.

He uses 6 hectares solely for private purposes, comprising 1 hectare on which his private dwelling is situated, and 5 hectares of surrounding land which is used for a tennis court, a swimming pool, and an extensive barbecue area.

The taxpayer uses the remaining 4 hectares of land, solely for the purposes of his business activity.

Division 35 of the ITAA 1997 applies to defer a non-commercial loss from a business activity carried on by a taxpayer who is an individual unless: • The taxpayer satisfies the income requirement in subsection 35-10(2E) of the ITAA 1997 and their business activity satisfies one of the four tests referred to in paragraph 35-10(1)(a); or • the Commissioner has exercised the discretion in section 35-55 of the ITAA 1997 for the activity; or • the individual comes within the exceptions contained in subsection 35-10(4). (refer paragraph 35-10(1)(c) of the ITAA 1997)

One of the four tests in paragraph 35-10(1)(a) of the ITAA 1997 is the real property test in section 35-40. This states that the non-commercial loss deferral provisions do not apply if the value of real property or interests in real property used on a continuing basis in carrying on the business activity in the relevant income year is at least $500,000. The value of the real property or interest is the reduced cost base of that property or interest or its market value if the market value is more than its reduced cost base.

Paragraph 35-40(4)(a) of the ITAA 1997 specifically excludes from the assets that can be counted for the purposes of the real property test a dwelling, and any adjacent land used in association with that dwelling, that is used mainly for private purposes. The word 'adjacent' was defined in Murray Goulburn Co-operative Co Ltd v FCT 99 ATC 4455; (1999) 42 ATR 34 as 'lying near, close, or contiguous; adjoining; neighbouring'. Accordingly, the 5 hectares of land surrounding the dwelling is adjacent land.

Section 118-120 of the ITAA 1997 provides an exemption from CGT consequences where a CGT event happens to land adjacent to a dwelling to the extent that the land is used primarily for private or domestic purposes in association with the dwelling. The maximum area of land covered by the exemption is 2 hectares. However, this exemption is only relevant for the purposes of the 'main residence' exemption under Subdivision 118-B of the ITAA 1997. It does not apply to section 35-40 of the ITAA 1997.

Division 35 of the ITAA 1997 makes no mention of a limitation on the area of adjacent land, so any area of adjacent land used in association with a dwelling that is used mainly for private purposes will be excluded from the assets that can be counted for the purposes of the real property test.

As the taxpayer uses the 5 hectares solely for private purposes and in association with the dwelling, the 5 hectares of adjacent land is excluded from the real property test in section 35-40 of the ITAA 1997.

However, the apportionment rule in section 35-50 of the ITAA 1997 will apply in relation to the remaining 4 hectares of land that is used for the purpose of carrying on a business activity.