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Tax Law – Cost Base(Part 1) – Costs of acquisition

A capital gain exists where the capital proceeds attributable to a capital event exceed the cost base of the relevant CGT asset. Capital proceeds are relatively simple to calculate. The more involved issue is the calculation of the cost base of the asset.

The five elements

The theory behind cost base calculation, is that CGT is a tax upon the increase in value of a CGT asset prior to the relevant CGT event. The calculation of the cost base attempts to determine the actual cost of acquiring and holding the CGT asset
The following are the five elements of the cost base of a CGT asset:
  • first element: the amount of money paid or assets given by the taxpayer to acquire the asset;
  • second element: incidental costs for the acquisition of the CGT asset;
  • third element: costs of owning the CGT asset;
  • fourth element: costs related to the improvement or preservation of the CGT asset; and
  • fifth element: costs related to the preservation or defending of rights or titles of the CGT asset.
None of these costs form part of the cost base if they are deductible expenses.

First element: Acquisition costs

The first element is obtained by adding together the money originally paid or required to be paid by the taxpayer to acquire the CGT asset, plus the market value of any property give or required to be given in respect of the acquisition.
The acquisition cost can include cancelled liabilities. Any acquisition cost does not need to have been paid or given to the entity that disposed of the asset to the taxpayer. It includes amounts paid or given to other entities nominated by that disposing entity.
The acquisition cost also cannot include any labour costs to acquire the asset. Any foreign currency amount is converted to Australian dollars.

Second element: Incidental costs

In the acquisition of a CGT asset there may have been incidental costs incurred that are not acquisition costs, exactly, but ought to be taken into account. These incidental costs include:
  • costs of transfer;
  • stamp duty or other similar duty;
  • advertising or marketing costs to find a seller;
  • costs of services provided by tax professionals, brokers, legal advisers, auctioneers and other consultants; and
  • borrowing expenses such as loan application fees and mortgage discharge fees.

Elements three to five will be dealt with in part 2 of this article.

Example: First and second elements
X is an individual taxpayer. She acquired an investment property in Turramurra NSW in 1993 for $270,000, from Y Co. Now, in December 2011, she wants to sell it.
At the time of acquisition X incurred the following expenses:
  • paid $270,000 to Y Co;
  • she cancelled a liability of Y Co to pay her $30,000;
  • she paid a further $30,000 to a director of Y Co, on the nomination of Y Co;
  • she paid $1000 in legal costs for advice on acquiring the property; and
  • she paid $90,000 in NSW stamp duty.
In total, the first two elements of X’s cost base add up to a total of $421,000.
(Note that this does not take into account inflation. X can choose to index for inflation, but only for the period up to 30 September 1999, and only if she foregoes the CGT general discount).

Conclusion

If you have concerns about calculating a CGT asset’s cost base, call LAC Lawyers and we can provide advice and assistance.

Part 2

A capital gain exists where the capital proceeds attributable to a capital event exceed the cost base of the relevant CGT asset.

The following are the five elements of the cost base of a CGT asset:

  • first element: the amount of money paid or assets given by the taxpayer to acquire the asset;
  • second element: incidental costs for the acquisition of the CGT asset;
  • third element: costs of owning the CGT asset;
  • fourth element: costs related to the improvement or preservation of the CGT asset; and
  • fifth element: costs related to the preservation or defending of rights or titles of the CGT asset.

None of these costs form part of the cost base if they are deductible expenses.

This part of the article deals with the third, fourth and fifth elements.

Third element: Ownership costs

The calculation of a cost base does not end with the mere cost of acquisition. The tax law recognises that ongoing costs attach themselves merely to holding a CGT asset for any length of time and that these costs, too, should be taken into account in calculating cost base.

The “third element costs” costs of expenditures incurred in relation to continuing ownership of the asset, and include the following amounts:

  • interest on monies borrowed to acquire the asset or refinancings;
  • costs of maintenance, repairs and insurance; and
  • rates and land taxes.

Fourth element: Improvement or preservation costs

Since any enhancement of a CGT asset will, in theory, be reflected in the capital proceeds upon its disposal, it is just that the costs of such enhancement should be part of the asset’s cost base.

The following are examples of costs related to the improvement or preservation of the CGT asset:

  • cost for upgrades or installation of features that will increase the value of the asset (such as a home theatre system for rental properties);
  • costs of installation of the asset;
  • costs for moving the asset; and
  • any non-deductible initial repairs to the asset.
Fifth element: Title costs

The final sort of cost that is recognised as part of an asset’s cost base, is that type of cost relating to actual establishment, preservation or defence of the taxpayer’s title to the CGT asset. Presumably this is because such costs are reflected in the fact of the taxpayer being able to hold the CGT asset until the CGT event occurred.

Fifth element costs include the following:

  • legal fees to defend the taxpayer’s title against litigation; and
  • damages paid by the taxpayer to a potential purchaser, where the damages are incurred because the taxpayer elected to repudiate the contract to sell the CGT asset to the purchaser.

Example: Costs of ownership

K acquired an investment property located in Carlingford NSW in December 1999. He now, in December 2011, wishes to sell the property.

During the years K held the property, K incurred the following expenses relating to ownership:

  • $90,000 in land tax;
  • $120,000 in repairs to drainage;
  • $500,000 in improvements which involved turning the vacant lot into a set of apartments;
  • $40,000 in interest on his loan to obtain the asset;
  • $30,000 in costs in seeking out and obtaining the loan; and
  • $3,000 in legal costs defending his legal title to the land.

In the above scenario, K can include all the amounts in the third, fourth and fifth elements of the cost base of the property, except for the $30,000 expense of seeking and obtaining the loan. This cost relates to the borrowing and not to the property itself, and therefore cannot be included in the third element of the cost base.

Conclusion

If you have concerns about calculating a CGT asset’s cost base, call LAC Lawyers and we can provide advice and assistance.

Part 3

A capital gain exists where the capital proceeds attributable to a capital event exceed the cost base of the relevant CGT asset. However, a capital loss exists where the capital proceeds are exceeded by the reduced cost base of the asset.

Purpose of reduced cost base

The purpose for having a different cost base depending on whether a gain or loss exists, is presumably to lessen the ability of the taxpayer to create a capital loss artificially by incurring expenses that are not obviously reflected in the state of the asset at the time of the CGT event.

Elements of a reduced cost base

The elements of a reduced cost base are identical to those for a cost base, except that the third element is replaced. The elements are as follows:
  • first element: the amount of money paid or assets given by the taxpayer to acquire the asset;
  • second element: incidental costs for the acquisition of the CGT asset;
  • third element: any amount assessable due to a balancing adjustment event, or which would have been assessable had balancing adjustment relief not been available;
  • fourth element: costs related to the improvement or preservation of the CGT asset; and
  • fifth element: costs related to the preservation or defending of rights or titles of the CGT asset.
None of these costs form part of the cost base if they are deductible expenses.

Conclusion

If you have concerns about calculating a CGT asset’s reduced cost base, call LAC Lawyers and we can provide advice and assistance.

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