Income Tax And CGT Implications For Inherited Property And Tax Deductibility Of Outgoings

Income and CGT Implications for Inherited Property

1. On the basis of the given information, the key issue is to highlight the income tax and CGT implications in relation to the inherited property left by Joe (Father) for Tony & Hub (Both sons).

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It is apparent that rent income has been received by the brothers to the tune of $ 12,000 and this would be assessable income as per s. 6(5) (Reuters, 2017). Since both the brothers have ownership on the property, hence the division of rent income between the two would be in proportion to the ownership share from inheritance.

It is noteworthy that inheritance is not categorised as a CGT event even through it leads to change in ownership but the asset has not been sold. Hence, the CGT consequences for the given property would arise if the property is liquidated. The levying of CGT would be contingent on a host of factors particularly time (Woellner, 2014).

In the context of dwellings that are inherited, there may arise a case where the residence or asset has been purchased before September 20, 1985 (pre-CGT era) but the purchaser tends to die after CGT comes into place. In accordance with s. 118-195, such assets would not be levied any CGT provided the inherited asset from the deceased is liquidated within two years from the time of death. Also, it is noteworthy that the above clause is independent of the usage of the property during the two years (Kreyer, 2017). Thus, even if it is used for income generation, then also CGT exemption would be available. For the situation at hand, Joe did build house on the land in the pre CGT era but expired after CGT was in place. Thus, selling of property on immediate basis would insulate the brothers from CGT implications (Coleman, 2015). This is despite the fact that income generation has been done by renting the property.

The sale proceeds would not be taxed owing to capital nature while the capital gains would also be exempt. The investment of proceeds in other assets is not of relevance for the given case (Barkoczy, 2017).

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The first aspect that is noteworthy here is that there is improvement and not repairs in the existing house since there is significant improvement which makes the house look like new. This is important since s. 25-10 provides deduction for repairs of rental property. However, in accordance with verdict in FCT v Western Suburbs Cinemas Ltd (1952) HCA 28, the expense of $ 200,000 would be considered as capital improvement and thus out of the domain of s.8-1 owing to negative limb prohibiting deduction for capital outgoings (Gliders,et. al., 2014).

Tax Deductibility of Outgoings

Thus, the net effect of the construction of new house and improvement in the old house would be an increase in the cost base of the given property as per s. 110-25 since one of the components of cost base is any capital expenditure which tends to enhance the value of the underlying asset (Wilmot, 2014).

The title of the two houses is being separated and the two would be liquidated. It is noteworthy that even though the property is inherited and hence free but the market value of the property at time of Joe’s death would be considered as acquisition cost (Kreyer, 2017).

Property acquisition cost = $ 1,000,000

Property improvement cost = $ 450,000

Total cost base (s. 110-25) = $1,000,000 + $ 450,000 = $ 1,450,000

Money generated from selling the two houses = $ 1,200,000*2 = $ 2,400,000

Gross capital gains from the transaction = $2,400,000 – $ 1,450,000 = $ 950,000

50% exemption under division 115 can be available which would reduce the taxable capital gains to $ 475,000.

Till the time the houses are sold, the brothers would continue to have assessable income in the form of rent. However, capital gains would arise when there is liquidation.

Total cost base (s. 110-25) = $1,000,000 + $ 450,000 = $ 1,450,000

Money generated from selling the two houses = $ 2,400,000*2 = $ 4,800,000

Gross capital gains from the transaction = $4,800,000 – $ 1,450,000 = $ 3, 350,000

50% exemption under division 115 can be available which would reduce the taxable capital gains to $ 1,675,000 (Wilmot, 2014).

2. The aim is to offer a legal advice to Monica regarding the tax deductibility for the various outgoings based on legislation and relevant case law.

It can be seen that Monica had spent $500,000 in order to buy a property that can be used for deriving income for her. Hence, it may be possible that outgoings to the tune of $500,000 would be taken for tax deduction under s. 8-1 ITAAA 1997(Reuters, 2017). However, according to subsection 8-1 (2) ITAA 1997, the amount which is categorised under capital outgoings would not be considered for tax deductions. Hence, the amount of $500,000 which is a capital expense would not be tax deductible under section 8-1 because the expense has been incurred for buying an asset and not for acquiring any trading stock. Further, as the capital expenses are tax deductible under s. 40-880 depending on whether the capital expense is of business nature or not (Kreyer, 2017)  In the present case, the capital expense of $500,000 is not of business nature and therefore, no tax deduction is applicable for Monica of the amount of $500,000.

  • “Establishment fee of $5,000”

References

According to s. 25-25 ITAA 1997, the establishment fee for loan is reported as borrowing expenditure for the taxpayer and has also used for deriving assessable income because it has used for renting a property. Thus, the amount $5,000 is tax deductible for Monica.

  • “Paid loan payment interest of $11,250 and the principal amount of $10,000”

According to the judgement given in Steele v DCT (1999) HCA 7, the loan amount which has used for purchasing a property that would be used to derive assessable income would be considered for tax deduction. In present case, Monica is using the loan amount for renting a property that would derive assessable income for her under s. 6(5) ITAA 1997and hence, would be tax deductible (Reuters, 2017). However, the loan repayment amount is considered as capital outgoing and would not be taken for tax deduction as per s. 8-1.

In the accordance of s. 25-10 ITAA 1997, the expenses incurred on repairs and maintenance would be considered for tax deduction in the same income year on which the repairing has been done and the assessable income has been received (Woellner, 2014). It is essential to note that repairing has been established prior to renting and hence, the expenses would be categorized as capital expenditure which would not be tax deductible as per s. 25-10        (Barkoczy, 2017). However, this amount would be considered into the cost base of the rental property and would not be deductible. 

As per s. 25-35(1) ITAA 1997, the doubtful debt of the taxpayer would be considered for tax deduction only when the doubtful debts are reported as assessable income either in the current year or in the last year income statement (Gliders,et. al., 2014). Hence, the amount $500 would be tax deductible for Monica only when she has reported $500 as her ordinary income for current financial year. It is noteworthy that if Monica has not reported $500 as her ordinary income then she cannot claim any tax deduction on this amount.

The relevant case law is FCT v Payne (2001) 46 ATR 228 case, where the travelling expenditure incurred on the part of taxpayer in regards to travel between the workplaces which are unrelated would not be considered for tax deduction under s. 8-1(Woellner, 2014).  However, deduction for travel expenses between unrelated workplaces is permissible under s. 25-100(1). The travel expense of $500 has incurred between Monica’s office and her university would be tax deductible only when the university is paying her for her teaching job.

It can be noticeable from the case that membership fee for the Australian Financial Planners Association would provide professional benefits to Monica as she is a financial advisor. Further, the membership fee would play a significant role in deriving assessable income. Hence, the membership fee of $450 would be categorised as business expenditure and would be tax deductible as per section 8-1(Wilmot, 2014). Further, the membership amount of $500 paid to the golf club would also be tax deductible under s. 8-1 because Monica used golf club for the entertainment of the clients which shows clear indication of the process of making professional relationship with the clients. Hence, as per verdict given in Hayley v FCT (1958) 100 CLR 478 case, the amount is tax deductible (Coleman, 2015).

References

Barkoczy, S. (2017) Core Tax Legislation and Study Guide 2017. 2nd ed. Sydney: Oxford University Press Australia

Coleman, C. (2015) Australian Tax Analysis. 4th ed. Sydney: Thomson Reuters (Professional) Australia.

Gilders, F, Taylor, J, Walpole, M, Burton, M. and Ciro, T (2014) Understanding taxation law 2013.6th  ed. Sydney: LexisNexis/Butterworths

Krever, R. (2017) Australian Taxation Law Cases 2017.2nd ed. Brisbane: THOMSON LAWBOOK Company.

Reuters, T. (2017) Australian Tax Legislation (2017).4th ed. Sydney. THOMSON REUTERS.

Wilmot, C. (2014) FBT Compliance guide. 6th ed. North Ryde:CCH Australia Limited.

Woellner, R. (2014) Australian taxation law 2014.8th ed. North Ryde: CCH Australia.