Capital and Interest Apportionment on Building a Duplex

Question

We bought an old property to live in which we rented out for around 1.5 years while we went through the DA Process to build. We found out that we could build a duplex, so we decided on that, with the intention of renting out the upper duplex and living in the other.

The property took 1.5 years to build, but in late 2008 (practical completion)when the GFC hit, we thought it safer to sell the property and went through the process of applying for a strata subdivision. We had both a rental agreement and a sales agreement in place at this time, but no tenants.

The property eventually sold (after a number of issues with the Strata and Council), so we also had a few months occupational rent at this stage as the sales contract was subject to the Strata being approved within 6 weeks. (it wasn’t but the purchaser and us decided to follow through).

As further background:
The building envelope of the duplex is exactly the same.
The total constructed area is similar around 55%:45% in favour of the property we live in.
We constructed a lawn over the garages, which we put on title for our apartment only – this was only completed towards the end of the build though.
The final amount of land on title upon completion was around 66:33 due to us having sole rights to use of the land above the garage.

Questions:
Can we apportion the original cost of the land and the interest 50:50 seeing that the building envelope is the same and the area was used to construct 2 very similar sized dwellings? Or how should this be done?
Can the cost of the construction costs be apportioned 55:45 based on the total constructed area?

Many thanks
Chris.

Answer

The ATO will accept a “reasonable” method of apportionment. In their ruling TD 97/3 they consider apportionment equally between the properties if they are similar. Otherwise on basis of each property’s relative market value.
Below are some extracts from the ruling. It seems to me that the market value approach would be the best method to apportion the original cost of the property. If you engage a valuer then you have the strongest case against the ATO and valuers are generally sympathetic to your wishes within a tolerance of about 10%. I also suggest you read my how not to be a developer booklet from the freebies section on this web site. You need to consider whether GST and normal income tax could apply if your intention was to build and sell at a profit. Or more correctly to make sure you do not do anything that may cause you to fall into that trap.

TD 97/3
Note : In determining, for the purposes of section 112-25, the extent to which it is reasonable to attribute each element of the cost base and reduced cost base of the original land to the corresponding element of the cost base and reduced cost base of each new block, we would accept any approach that is appropriate in the circumstances of the particular case, e.g., on an area basis or relative market value basis.
Example 1
Albert subdivides land, which he purchased in 1986 for $150,000, into 5 blocks of equal size and value. On the registration of new titles, the original asset (the land) is ‘split’ into 5 separate assets for CGT purposes (i.e., the subdivided blocks). In this case it would be reasonable to attribute $30,000 of the original cost to each block. Albert then sells one block for $200,000. Albert would make a capital gain of $170,000 on the disposal of the block that is, $200,000 less $30,000 (assuming no other amounts are included in the cost base of the asset).
Note: In any land subdivision, the potential application of the revenue provisions must be considered. In the example above, we have assumed that the land is not trading stock and that the net profit is not assessable income under section 6-5.
Example 2
John subdivides his post-CGT land into two new blocks with a view to selling one and retaining the other. He incurs the following costs:
survey fees; legal fees; subdivision application fees; and cost of connecting electricity and water only to the subdivided block to be sold.
John includes all of these costs in the relevant cost base of the block to be sold. We consider that this is not a reasonable apportionment. It is reasonable to apportion the survey, legal and subdivision application fees over both blocks. If the blocks are of unequal market value, an apportionment of costs in proportion to the market value of the blocks would usually be a reasonable apportionment. As the cost of connecting the electricity and water relates only to the block to be sold, it would be reasonable to attribute this cost solely to the cost base of this block.
A reasonable apportionment of the cost of the land itself can usually be achieved on an area basis if all the land is of similar market value or on a relative market value basis if this is not the case.
Example 3
Jane purchases one hectare of land in 1992. Part of the land is a good quality building block (one-quarter of a hectare) worth 75% of the total market value of the property. The balance of the land is low-lying flood-plain. In 2007, Jane subdivides off the flood-plain. It would be reasonable in the circumstances to apportion 75% of the original acquisition cost of the property to the ‘building block’ and 25% to the ‘flood-plain’.



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