z5001560

TABL 2751 Assignment

Introduction
Robert who is an Australian resident taxpayer bought a house at $500,000 in
Sydney on 1 July 2003. There are various transactions occurred with regard to
this property before he sell it at 1 March 2016. The paper provides advice on the
tax consequence for each of the transaction including calculation of capital
gain/loss on the sale of the property. All sections that are applied in the paper
are from Income Tax Assessment Act 1997.

Rental income

Referring to Yanchep Sun City Pty Ltd v CT (WA)1, rent is payment received by a
lessor in return for the use by a lessee of property. Rental income is ordinary
income that is included in taxpayers assessable income under s6-5. Therefore,
rent Robert received from tenants during 1 July 2005 to 1 July 2012 and 1
August 2012 to 1 August 2013 is his assessable income.

Income year

Rental income (assessable income)

1/7/200530/6/2012

500/7 * 365 = $26071 per income year

1/8/2012-30/6/2013

650/7 * 334 = $31014

1/7/2013-30/6/2014

650/7 * 31 = $2879

Purchase the property

At 1 July 2003, Robert signed a contract to purchase a house for $500,000 that
consists of a deposit of $50,000 and a 25-years mortgage of $450,000. The
acquisition cost is not deductible under s8-1(1)2 because it does not incur in

1
2

Yanchep Sun City Pty Ltd v CT (WA) (1984) 15 ATR 1165

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gaining or producing assessable income. Besides, it violate negative limbs under

s 8-1(2)3owing to the fact the outgoing is domestic expenditure.

Stamp duty & conveyancing fees

The stamp duty and conveyacing fee is not deductible under s8-1 or specific
deduction provision, as they are not nexus to the income. However, referring to
s110-354, these incidental costs are included in the cost base as 2nd element5,
which will raise tax benefits in the disposal of the property in the future.

Borrowing expense

The borrowing expense is not deductible under s8-16 because it is capital in
nature. However, under s25-257, taxpayer can deduct the borrowing expense to
the extent that the borrowed is used for the purpose of producing assessable
income. Therefore, borrowing expense is not deductible until Robert rend the
property out at 1 July 2005. The deduction is spread over the period that is
either 5 years or the life of the loan if it is less than 5 years. The non-deductible
amount of borrow expense can be included in the 2nd element of the cost base.

Interest expense
Interest expense is deductible under s8-18 to the extent that borrowed money is
used to generate assessable income. Thus interest expense incurred by a

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6
7
8
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purpose other than generating assessable income is not deductible under s8-19.
As Munro v FCT10, the use test was established to evaluate whether an interest
expenses has been incurred in the course of producing assessable income, and
apportion is implied if the principal is not solely used for the purpose of
producing assessable income. The proportion of deductible interest will be equal
to the proportion of capital that had been used to derive assessable income11. In
this case, the house is not solely for the purpose of earning rental income. Thus,
the interest expense incurred during tenancy is deductible otherwise the interest
expense is included in the cost base as 3rd element12.
Income year

Deduction

1/7/2005-30/6/2012

450,000 * 7% = $31500 per income year

1/7/2013-30/6/2014

31500 * 93/365 = $8026

Total deduction

31500 * 8 + 8026 = $260,026

(1/7/2005-1/10/2013)
Total interest expense

(12+214/366) * 31500 = $396,418

(1/8/2003 1/3/2016)
Non-deductible interest expense

$136,392 (will be included in cost base)

Cost of repainting
The repainting expense incurred not deductible under s8-1 because the expense
is capital in nature13. This expenditure is not deductible under division 25 as well
because the expense related to the period before the property became an
income-producing property14. Similar to initial repair in law shipping case, the
expenditure is not deductible because the disrepair related to predecessors

9

10

TR 95/25
12 s110-25
13 s8-1(2)
14https://www.ato.gov.au/printfriendly.aspx?url=/Individuals/Ind/Rental-properties---claiming-repairs-a
nd-maintenance-expenses/
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trade. Referring to Lunney v FCT15, expense with regard to prerequisite to

produce income does not mean it is incurred in gaining assessable income. In
this case, the purpose of repainting is to put property into a rental condition, and
the disrepair incurred by private use or predecessor. Thus, the expenditure of
repainting is considered as capital in nature. However, Robert can claim
deduction for this expense under capital work allowance division 43. As the
property is not solely bought for rental purpose, apportionment is required.
Referring to s43(c), you can only deduct the amount of you use your area in the
income year in the way set out in s43-140. Therefore only the portion of
repainting expense with regard to produce assessable income is deductible..
Once construction is completed16, taxpayer is entitled to deduction at rate
specified under s43-25.
Applied section: s43-25

40 years at 2.5%

Income year

Deduction

1/7/2004-30/6/2005

16/365 * 8000 * 2.5% = $9

(Construction completed at 15/6/2005)

1/7/2005-30/6/2013

8000 * 2.5% = $200 per income year

1/7/2013-30/6/2014

93/365 * 8000 * 2.5% = $51

Total deduction

200 * 8 + 9 + 51 = 1660

Non deductible amount

8000 1660 = $6340

(will be included in cost base)

Plumber
Expenditures incurred for repairs are not deductible if repairs are capital
expenditure17. In this case, clarifying a distinction between repair and
improvement is required in order to claim deduction for this expense because

15

Lunney v FCT (1958) 100 CLR 478

s43-30
17 s25-10(3)
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expenses incurred by improvement are capital in nature. W Thomas & Co case

18highlights that repairs involves restoration of a thing to a condition it formerly

without changing its character. Fixing dripping taps was clearly to restore taps
function so that the house would return to the former condition. This repair is a
specific deduction under s25-10, and this expense is also deductible under s8-1.
However, referring to s8-10, taxpayers cannot claim double deduction and is
required to claim deduction under the most appropriate division.
Apportionment is required because Robert did not hold the property solely for
income-producing purpose19. Nevertheless, it is difficult to determine the
proportion attributed to the income-producing purpose. I assume the disrepair
is fully incurred by tenants.
Applied section: s25-10
Income year

Deduction

1/7/2009 30/6/2010

$400

Cost of replacing the entire roof
Replacement of the entire item is not a repair, and thus it is not deductible under
s25-10. Referring to Lindsay v FCT, functional entity test is established to assess
whether what is done is the replacement of subsidiary part of an entirety. In this
case, the replaced roof is a subsidiary of an item rather than an entirety.
However, as the issue involved fixing dripping taps, the distinction between
improvements and repairs is required be clarified with regard to replacement of
the roof. Referring to Western Suburbs Cinema case20, the replacement of entire
ceiling did much more than meet a need for restoration due to using a better
material, and thus it is an improvement. Similar to this case, Robert replaced the
entire roof with materials that are better than the original materials so that the

18

W Thomas & Co v FCT (1965) 115 CLR 58

s25-10(2)
20 FCT v Western Suburbs Cinema (1952) 56 CLR 102
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new roof changed character of property by adding new function. Therefore, the
replacement of roof is improvement which is not deductible under s25-10.
However, the expense of replacing the roof is deductible under division 43. As
discussion in repainting expense, immediate deduction is not allowed under
division 43 but taxpayers can claim deductions over the life of the asset under
capital allowances regime. Thus, Robert is entitled to deduction at the rate
specified under s43-25 once the construction is completed21. Apportionment is
applied to this expense as the same reason for repaint expense.
Applied section: s43-25

40 years at 2.5%

Income year

Deduction

1/7/2010-30/6/2011

303/365 * (11000+3000) * 2.5% =

(Construction completed at

$291

1/9/2010)
1/7/2011-30/6/2013

14000 * 2.5% = $350 per income year

1/7/2013-30/6/2014

93/365 * 350 = $89

Total deduction

350 * 8 + 291 + 89 = $ 780

Non deductible amount

$13220

Cost of replacing carpets
This expense is capital in nature, and thus it falls under uniform capital
allowance division 40 that allows taxpayers to deduct an amount equal to the
decline in value of depreciating assets that they hold for the taxable purposes.
Referring to s40-30, carpets are depreciating assets. Since the carpet was
purchased post 10 May 2006 using diminishing value method, s40-72 is applied
here. Base value, effective life, and days hold are key factors in calculating
deduction for the assets22. Base value at beginning year is defined by s40-10(1),

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s43-30
s40-72

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consisting first element and second element in the cost base23of the asset. Under
s40-10(1), days hold are counted from the first day that taxpayers hold assets,
which is the purchased date in this case. Effective life of assets can be
determined either by commissioner or by taxpayer24. Referring to TR 2015/2,
effective life for carpet is 10 years. In terms of deductions in subsequent years,
base value is combination of opening adjustable value and 2nd element25 of cost
for that year26. The deduction rates are the same during the life of the asset but
choice of depreciation method cannot be changed27. As previous discussion, the
apportionment is required in this case so that the deduction reduced where
assets decline in value attributable to its use for a purpose other than a taxable
purpose.
Applied section: s40-72
Effective life of carpet (TR 2015/2)

10 years

Base value (s40-10)

$8000

Income year

Deduction

1/7/2012-30/6/2013

8000 * 365/365 * 200%/10 = $1600

(start holding the asset at 1/7/2012)

1/7/2013-30/6/2014

(8000-1600) * 93/365 * 200%/10 =

$326

Balancing adjustment of carpets

In the problem, balancing adjustment events28 related to carpets have occurred
twice on 1 July 2012 and 1 March 2016 respectively. The former happened when

23
24

s40-95

26 s40-85
27 s40-130(2)
28 s40-295(1)
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original carpets were replaced due to being worn. The latter happened when
Robert signed contract to sell the property so that he stopped holding the new
carpets. If termination value exceeds adjustable value, excess is included in
assessable income29. Otherwise it is deduction30. Based on the fact, the
termination value31 of the old carpet is zero but there is no sufficient
information to derive its excess. In terms of the new carpet, termination value is
included in the total consideration for the house and thus apportionment is
required in determining its termination value32. There is no sufficient
information to calculate its excess as well.
Applied section: s40-285
Adjustment value of old carpet

Insufficient information

Termination value of old carpet

$0

Adjustment value of new carpet

8000-1600-1280-1020-(245/365 *
4100 * 200%/10) = $3550

Termination value of new carpet

Insufficient information

Legal fees & damages
Legal fees can be classified either capital or revenue in nature depending on the
purpose of incurring the legal fees33. Under general deduction provision,
taxpayers can claim deduction for any loss or outgoing to the extent that it is
incurred in producing assessable income34. As Robert did not carry on a business
with regard to rental property, the 1st limb under s8-1(1) (a) is appropriate for
this case. It concerned with expense incurred in the actual course of producing
assessable income. Incidental and relevant test developed from the decision in

29

s40-285
ibid
31 s40-300
32 s40-310
33 Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; 8
ATD 190
34 s8-1(1)
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Herald and Weekly Times Ltd v FCT 35in which Legal fee & damages incurred by
libel are deductible because they were incidental to taxpayers business. The
principles advocated in Herald case were applied in Case C1236 where allowing
a deduction for the settlement of damages claim with regard to tenants injuries
caused by rental property. Referring to Australian Taxation office interpretative
decision 2003/48437, taxpayers can claim the cost of defending a damages claim
in respect of injuries suffered by a third party on their rental property. Therefore,
the Legal fee & damages for defending a damages claim in respect of injury is
deductible because it incurred in the course of gaining assessable income.
Income year

Deduction

1/7/2012-30/6/2013

$30000

Advertising for tenants

Expense incurred by advertising for tenants is deductible under s8-1. To be
deductible under s8-1, outgoings have to be nexus to income. Incidental and
relevant test is one of judicial tests that are used to confirm whether there is a
sufficient nexus between the expenditure and the income. Advertisement for
tenants does not directly generate assessable income. However, tenants are
sources of rental income, whereby it is incidental to produce assessable income.
As W Neil & Company Ltd v FCT38, the redundancy payment did not generate any
income but it is deductible based on the object of expense. Apportionment is not
required here because the adverting expense is solely for the purpose of
producing assessable income.


35 Herald and Weekly Times Ltd v FCT (1932) 48 CLR 113
36 Case C12(1952) 3 TBRD 100
37http://law.ato.gov.au/atolaw/view.htm?rank=find&criteria=AND~negligence~basic~exact&target=J%2
0JA&style=html&sdocid=AID/AID2003484/00001&recStart=1&PiT=99991231235958&recnum=4&tot=7&
pn=ALL:::JA
38 W Neil & Company Ltd v FCT (1937) 56 CLR 290

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Income year

Deduction

1/7/2013-30/6/2014

$900

Mortgage discharge
However, this expense is deductible under specific deduction s25-30 that allows
deduction of mortgage discharge expense to the extent that you used the money
or property for income producing purpose. In this case, only part of the expense
is deductible under s25-30 but the non-deductible portion can be included in the
cost base as 2nd elements so that it would minimize his taxable income.
Applied section: s25-30
Total length of mortgage

4597days (1/8/2003-1/3/2016)

Income-producing period

3015 days (1/7/2005-1/10/2013)

Income year

Deduction

1/7/2015-30/6/2016

1000 * 3015/4597 = $656

Total expense

$1000

Non-deductible amount

$344 (will be included in cost base)

Advertising for sale & Real estate commission & Stamp duty & legal fees
Similar to the incidental expense of acquiring property, expenses incurred in sale
of the property are not deductible but can be include in cost base39 as 2nd
element so that they can reduce capital gain from disposal of property.

Real estate fees & council and water rate
These expenses incurred in the courses of gaining assessable income, and thus
there are sufficient nexus between expenses and income. Hence, these expenses
are deductible under s8-1. Only part of pre-paid council water rate expense is
attributed to income-producing purpose during 2013, and thus the expenses

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need to be apportioned40.

Income year

Deduction

1/7/2005-1/7/2012

2000 + 2300 = $4300 per income year

1/7/2012-30/6/2013

2500+2400 = $4900

1/7/2013-30/6/2014

200 + 3/12 * 2600 = $850

Construction expenditure of the property
As discussion in respect of repainting expense, division 43 allows deduction fir
construction expenditure on buildings and other capital works. Due to the fact
that the house is rented to produce assessable income, Robert is entitled to claim
deduction for construction expenditure on the property under division 43 at rate
specified in s43-140 during the rental periods. Due to the fact that deduction
cannot overwhelm amount of un-deducted construction expenditure41, the
amount that Robert is entitled to claim deduction for construction expenditure
depends the amount that predecessor had been claimed. There is no sufficient
information to derive the deduction that Robert is entitled to. Besides, if
taxpayer has claimed deduction for construction expenditure, it will reduce cost
base of the property42. Consequently it will affect capital gain tax with regard to
disposal of the property. There is no balancing adjustment with regard to capital
works on sale.

Disposal of the property
Capital gain or loss can only be made when Capital Gain Tax (CGT) event43

40

s8-1
s43-15
42https://www.ato.gov.au/General/Capital-gains-tax/In-detail/Real-estate/Calculating-the-cost-base-of-re
al-estate/?page=2
43 s104-5
41

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happened.44 The property is a CGT asset45, and CGT event A1 occur when Robert
sign sale contract.46 Hence, the capital gain or loss from disposing the property
is recognized on 1 March 2016. If the capital proceeds exceed cost based, the
excess is capital gain.47 Referring to s116-20, capital proceeds is $870,000, and
the cost base is presented in the following table consisting of five elements48.
Robert has held the property for more than 12 months so that the capital gain
can be discounted by 50%49.

Main residence exemption
Robert did not acquire a new property in Melbourne, and assuming that he did
not have any other property in Australia. Main residence exemption can be
applied to disregard capital gain from disposal of the property50. However,
Robert cannot obtain the full main residence exemption because he used the
property to produce income during partial ownership period. According to
special rule for first use to produce income51, taxpayers are entitled to a full
exemption for the dwelling immediately before they begin renting it out.
Furthermore, taxpayers are taken to have acquired the dwelling at its marker
value at the time that they used it to produce income52. Referring to absence
rule53, if taxpayer uses their main residence for the purpose of generating
assessable income, the maximum period that the property can be treated as main
residence is 6 years. Hence, the market value at 1 July 2005 is used in calculating
cost base, and Robert is fully exempted for the period before this date. Besides,
Robert is entitled to treat the property as main residence during his absence for

44

s102-20
s100-25
46 s104-10
47 s104-10(4)
48 s110-25
49 s115-25 & 115-10
50 s118-115
51 s118-192
52 ibid
53 s118-145
45

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six years that is form one July 2005 to thirty June 2011.

Capital gain tax & Main residence exemption

CGT Event A1

ITAA97

Value

Capital proceeds

$870,000

Money received from CGT s116-20

event
(Less) Cost base

s110-25

1st element: acquisition

s110-25(2)

$600,000

cost

s119-192 (2)

(Market value at

Purchase of property
2nd element: incidental

1/7/2005)
s110-25(3)

cost

Stamp duty (acquiring +

$18,000+$30,000

disposal)

Advertising (disposal)

$1,500

Legal fees (acquiring +

disposal)

$1,000+$1,800

Borrowing cost

remaining

$1,001

Mortgage discharge

$344

remaining
3rd element: cost of

s110-25(4)

ownership

Interest expense

$ 136,392

remaining

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Repaint expense

$6,340

remaining
4th element: expenditure

s110-25(5)

to increase or

preserve/install or move

an asset

Replacement of roof

$13,220

remaining
5th element: expenditure

s110-25(6)

Nil

Total cost base

s110-25

$809,587

Capital gain

s104-10(4)

$60,403

to establish, preserve or
defend title

Main residence exemption: s118-115

Special rule for first use to produce income: s118-192
Absence rule: s118-145
Ownership period days

1/7/2005-1/3/2016

Non-main residence days 1/7/2011-12/31/2013

3897 days
915 days

Total Capital Gain * (Non-main residence days/Ownership period days) =

60403 * (915/3897) = $14,182
(Less) Capital discount of s115-10

$14182 * 50% =

50%

$7091

Net capital gain

s102-5

$7091

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