1 Is the settlement amount incurred by you under the consent order form part of the cost base of the property under subsection 110-25 of the Income Tax Assessment Act 1997 (ITAA 1977)?
No. The settlement amount paid will not form part of the cost base of the property. Question 2 Are the legal costs incurred by you in regard to the consent order form part of the cost base of the property under subsection 110-25 of the ITAA 1977? Answer No. The legal cost incurred and paid by you will not form part of the cost base of the property. This ruling applies for the following period : Year ended 30 June 20YY The scheme commenced on: DD MM YYYY
On DD MM 20YY, you purchased a residential property (the property). The property was acquired solely in your name with your parents as guarantors on the mortgage. From the date of acquisition until MM 20YY, the property was rented out to tenants. You were in a De facto relationship for a number of years with ex-partner, prior to your De facto relationship you were together for X years moving between parents' homes. Your ex-partner did not have any legal ownership interest in the property, nor did their name appear of the property title. At no time did your ex-partner make any contributions to the purchase price, loan repayments, maintenance, or renovation costs of the property. At a date provided in your application, you and your ex-partner commenced living in the property together as your principal place of residence. You and your ex-partner shared all other living expenses. When you were living together, extensive renovations were carried out on the property by you with the assistance of family and friends. The renovations were funded entirely by you. Your relationship with your ex-partner ended.
Following the breakdown of the relationship, you received correspondence from ex-partner's solicitors asserting that your ex-partner was entitled to receive a financial payment from you arising from their period of cohabitation in the property. Your ex-partner's claim was based on their being the primary home maker in the relationship. You have provided the orders by consent document and the orders by consent minutes. The consent orders had an agreement settlement amount. You paid the settlement to prevent escalation into formal legal proceedings (such as family law or equitable claims) that could have impacted your ability to sell the property. You incurred legal fees in relation to the dispute and settlement with your ex-partner. Due to financial pressures from the settlement, you decided to sell the property. On a date provided, you entered a contract to sell the property. On a later date, you paid the settlement of the dispute from the property proceeds.
Income Tax Assessment Act 1997 section 8-1 Income Tax Assessment Act 1997 subsection 110-25
The general rules for allowable deductions are contained in section 8-1 of the ITAA 1997 which allows a deduction for a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature. In determining whether a deduction for legal expenses is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered. The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. Division 110 ITAA 1997 sets out the cost base and reduced cost base of the fifth element of capital asset which is: expenditure to establish, preserve or defend title. An example of this is where someone else lays a claim to the asset in whole or in part and institutes legal proceedings to establish that claim. The taxpayer's costs in defending those proceedings would be costs in defending the taxpayer's title".
Subsection 110-25(6) of the ITAA 1997 details the and fifth element of the cost base of a capital gains tax (CGT) asset includes capital expenditure incurred to increase or preserve the asset's value and capital expenditure that you incurred to establish, preserve or defend your title to the asset, or a right over the asset. The characterisation of legal expenses as an outgoing on revenue account or an outgoing of capital nature will depend on the cause or purpose for which the legal expenses were incurred (xx. v Federal Commissioner of Taxation (1946) 72 CLR 634; [1946] HCA 34; 8 ATD 190; (1946) 3 AITR 436). The question of whether expenditure is of a capital nature revolves around the character of the advantage sought by the expenditure, whether an enduring benefit is obtained as a result of the outgoing ( xx v FCT (1938) 61 CLR 337 and xx v FCT (1965)112 CLR 386). Where expenditure is devoted towards a structural rather than an operational purpose, the expenditure is of a capital nature and the expenses are not deductible ( xx Newspapers ).
For legal expenses to constitute an allowable deduction, it must be shown that they were incidental or relevant to the production of the taxpayer's assessable income, ( xx & xx v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431). In your case you cannot claim the legal fees or the settlement payment, as they are not sufficiently linked to the production of your assessable income. Therefore, they would be considered of a private or domestic nature. As stated on the ATO website search QC66065 general legal costs relating to the relationship breakdown or property settlement are not included in the cost base of an asset on transfer. No other provisions of the ITAA 1997 or the Income Tax Assessment Act 1936 will otherwise allow a deduction to be claimed for the settlement amount or the legal expenses. Application to your circumstances In your case, it was a claim from your ex-partner for an entitlement arising from their period of cohabitation in your property. The payment made to your ex-partner was made to prevent you from entering a formal legal proceeding within the family law or equitable claims.
The settlement sum, and the legal costs incurred by you in resolving this claim, do not satisfy the requirements of the fourth or fifth element of the cost base of a CGT asset as detailed in subsection 110-25(5) of the ITAA 1997. As per subsection 110-25(6) of the ITAA 1997, the fifth element is capital expenditure that you incurred to establish, preserve or defend your title to the asset, or a right over the asset. In your case the legal action taken against you was not a dispute against the title of the property or the right to the property rather a request for a payment due to cohabitation. We consider relationship breakdown do not form part of the cost base. Therefore, the legal cost and settlement amount will not form part of the cost base under section 110-25.