Issue
Is a taxpayer who made a capital improvement to land acquired before 20 September 1985 required to use the indexed cost base of the improvement when applying the tests in subsection 108-70(2) of the Income Tax Assessment Act 1997 (ITAA 1997) to determine whether the improvement is a separate CGT asset, if the improvement was undertaken before 21 September 1999?
Decision
Yes. As the requirements in Division 114 of the ITAA 1997 are met, the taxpayer is required to use the indexed cost base for the purposes of determining whether the tests in subsection 108-70(2) of the ITAA 1997 are satisfied.
Facts
A taxpayer purchased vacant land before 20 September 1985. After this date, but before 21 September 1999, the taxpayer entered into a contract to make a major improvement to the land. The improvement cost $100,000.
The taxpayer entered into a contract to sell the improved land in the 2005-06 income year for $500,000.
The indexed cost base of the improvement at the time of entering into the contract was $110,000.
The improvement threshold for the 2005-06 income year is $109,447.
Reasons for Decision
Subsection 108-70(2) of the ITAA 1997 provides that a capital improvement to a CGT asset that you acquired before 20 September 1985 (that is not related to any other capital improvement to the asset) is taken to be a separate CGT asset if its cost base (assuming it were a separate CGT asset), when a CGT event happens to it, is: - more than the improvement threshold for the income year in which the event happened, and - more than 5% of the capital proceeds from the event.
To determine whether the improvement in this case is a separate CGT asset, its cost base must be compared with the improvement threshold for the 2005-06 income year and the capital proceeds from the disposal of the improved land.
An issue arises as to whether indexation must be included in the cost base of the improvement when applying these tests.
Subsection 110-25(7) of the ITAA 1997 provides that the cost base of a CGT asset that a taxpayer acquired at or before 11.45 am on 21 September 1999 includes indexation of the elements of the cost base (except the third element) if the requirements of Division 114 of the ITAA 1997 are met.
Broadly, Division 114 of the ITAA 1997 requires that the asset must have been acquired at or before 11.45 am on 21 September 1999 and owned for at least 12 months before the CGT event.
Although subsection 110-25(8) of the ITAA 1997 provides that, for CGT events happening after 11.45 am on 21 September 1999, the cost base of an asset includes indexation only if an eligible entity so chooses, this is only for the purpose of working out the amount of a capital gain from the asset. The entity cannot choose to exclude indexation from the cost base of an asset when applying subsection 108-70(2) of the ITAA 1997.
As the improvement in this case was acquired before 21 September 1999 and it was owned for at least 12 months, its cost base includes indexation for the purposes of applying subsection 108-70(2) of the ITAA 1997. As this amount is more than: - the improvement threshold for the 2005-06 income year ($109,447), and - 5% of the capital proceeds from the disposal of the land ($25,000),
the improvement will be a separate CGT asset.
Having established that the improvement is a separate asset from the land, the taxpayer (if eligible) can work out their capital gain from its disposal using the CGT discount method or choose that the indexed cost base method apply. Note: the taxpayer would still use the indexed cost base to determine whether the improvements were separate assets for the purposes of the test in subsection 108-70(2) of the ITAA 1997 even if they would make a capital loss on its disposal.