Edited version of private advice

Authorisation Number: 1051893459690

Date of advice: 14 October 2021

Ruling

Subject: Capital gains tax

Question 1

Will the vacant land be CGT exempt on the basis that it was occupied prior to 20 September 1985?

Answer

No.

Question 2

Will a full main residence exemption apply to the vacant land?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The deceased purchased a dwelling several decades ago and before 20 September 1985.

The residential property was located on adjoining freehold titles.

The freehold property is a vacant residential property adjoining the main residence.

The residential property was the main residence of deceased for a few decades.

The deceased adversely possessed the vacant land.

This land was used in conjunction with an adjoining property.

The fence was removed and the vacant land was used as their own, maintaining it and using it as an extension of the existing dwelling.

The deceased established a substantial garden and erected outbuildings, and this became part of the main residence

The deceased did not apply for a title to the vacant land until many years after taking adverse possession of the property. This occurred well post 20 September 1985.

An application for a title was lodged and the title was issued in the same year.

The deceased's parent died a couple of years prior to the title being obtained.

At some stage after the deceased's parent died the deceased's moved into the parent's house.

The deceased passed away several years later.

The property was less than X Hectares.

Both properties were never rented out. No income was derived from the property.

The titles were sold under the one contract.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 118-185

Income Tax Assessment Act 1997 section 118-195

Income Tax Assessment Act 1997 subsection 109-5(1)

Reasons for decision

A capital gain or capital loss may be disregarded under section 118-195 of the Income Tax Assessment Act 1997 (ITAA 1997) where a capital gains tax event happens to a dwelling if it passed to you as an individual and a beneficiary of a deceased estate or you owned it as the trustee of the deceased estate.

For a dwelling acquired by the deceased prior to 20 September 1985, you will be entitled to a full exemption if:

The dwelling was, from the deceased's death until your ownership interest ends, the main residence of one or more of the following individuals:

•         the spouse of the deceased immediately before death (except a spouse who was living permanently separately and apart from the deceased)

•         an individual who had a right to occupy the dwelling under the deceased's will, or

•         an individual beneficiary to whom the ownership interest passed and the CGT event was brought about by that person, or

•         your ownership interest ends within two years of the deceased's death.

For a dwelling acquired by the deceased on or after 20 September 1985, the dwelling must have been used as the deceased's main residence just before their death and not used to produce assessable income at that time.

Adjacent land to a dwelling can be considered as if it were a dwelling for the purpose of Subdivision 118-B. Land adjacent to a dwelling is its adjacent land to the extent that the land was used primarily for private or domestic purposes in association with the dwelling.

The vacant land in this case was primarily for domestic purposes in association with the main dwelling until the deceased moved out of the property.

Therefore, the vacant land will be considered a separate dwelling for the purposes of analysing section 118-195 ITAA 1997.

Whether the vacant land was acquired by the deceased pre-CGT or post-CGT

ATO Interpretative Decision ATO ID 2004/731 Income Tax Capital gains tax: acquisition of asset: adverse possession considers when a person has acquired a property under adverse possession.

Division 109 of the ITAA 1997 sets out when you are taken to have acquired an asset for CGT purposes. In general, you acquire a CGT asset when you become its owner: subsection 109-5(1) of the ITAA 1997.

In this case the deceased did not become the registered proprietor of the land until after 19 September 1985. However, the law recognises that in special circumstances title to property can be acquired based on a claim of adverse possession.

In order for title to property to be acquired by adverse possession, the person claiming title must establish that the time limit on the right of the registered proprietor to recover possession of the land has expired and that they satisfy the common law requirements of adverse possession.

In this case the property was located in State Z. In State Z, the relevant limitation period for bringing actions to recover land is XX years from the date on which the right of action accrued. Once the limitation period has expired, the title of the person entitled to bring an action to recover the land is extinguished.

At common law, to extinguish the registered proprietor's title, the possession must be open, not secret; peaceful, not by force; and adverse, not by the consent of the true owner: Mulcahy v. Curramore Pty Ltd [1974] 2 NSWLR 464 at 475.

In this case, the relevant limitation period expired after 20 September 1985. The deceased obtained possessory title to the land after 20 September 1985.

Therefore, the deceased would have acquired their ownership interest in the vacant land after 20 September 1985.

The vacant land was not being used by the deceased as their main residence just before they died which is a requirement of section 118-195 for post CGT dwellings for a full exemption.

Any capital gain on the vacant land cannot be disregarded under section 118-195 of the ITAA 1997. The deceased had not used the vacant land in conjunction with the main residence since around their father's death.

Partial main residence exemption from CGT

If you are not fully exempt, you may be partially exempt if:

•         the dwelling was your main residence during only part of the period you owned it

•         you used the dwelling to produce assessable income, or

•         the land on which the dwelling is situated is more than 2 hectares.

Section 118-185 of the ITAA 1997 provides that you are entitled to a partial exemption from CGT where a dwelling was your main residence for part of your ownership period. Subsection 118-185(2) of the ITAA 1997 provides a formula (listed below) which allows you to adjust the capital gain or capital loss amount calculated on disposal of the property to take into account the proportion of your main residence days in the property to the total number of ownership period days of the property.

Total Capital Gain X Number of days the dwelling was your main residence

Total number of days you owned the property

The capital gain will be calculated as the difference between the capital proceeds received on the disposal of the dwelling, and the dwelling's cost base.

Days in your ownership period will be the total days from the date of settlement of the contract of purchase of the dwelling until the date of settlement of the contract of sale when the dwelling is sold.

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