Pre-CGT farmland is not always tax exempt

Over the years of my consulting on property tax matters, it has always surprised me as to how few rural property owners realise that property acquired before the Capital Gains Tax (CGT) regime (ie pre-20 September 1985) is not always exempt from CGT when sold.

When a breeding property is sold, or subject to offer, it's generally the time our office is contacted by anxious vendors to sort out the tax implications of the sale and, where possible, plan to reduce the tax on sale. The thing we least like telling them is what they thought was a 100% tax free sale can, in certain circumstances, be subject to CGT.

If you don't want a nasty tax surprise when you sell that "old family property in the bush", I suggest you read this article as it spells out when a separate CGT asset is created on pre-CGT farmland and what the CGT implications are when it's sold.

Can pre-CGT property attract CGT on sale?

Many breeders have farmed the family property for years and there is a perception that as it was acquired in the family many generations ago, CGT can never apply to the sale of this property.

Yes..CGT assets acquired prior to 20 September 1985 are referred to as 'pre-CGT assets' and thus generally not subject to the CGT regime.

However, certain assets are specifically subject to CGT despite being "pre-CGT" assets. In particular, breeders should note that capital gains and losses will not be exempt from CGT where the following circumstances apply:

Farmland was acquired pre-CGT, and a building was constructed on (or significant capital improvement were made to) the land on or after that date, to the extent that the building/improvement constitutes a separate CGT asset .

Where the has been a change in the underlying ownership of a pre-CGT company or trust that owns the property.

I won't discuss b) above as it's just too technical for our purposes, but seek out your adviser if you think this could be an issue.

What is a "separate CGT asset"?

Under common law, buildings, structures and capital improvements on farmland form part of the farmland itself. As such, the farmland and any attached buildings/structures/improvements are treated as a single CGT asset .

However, where farmland is acquired prior to 20 September 1985, the CGT rules will apply to treat the sale of a portion of the pre-CGT farmland as being subject to CGT in the following scenarios:

A building or structure constructed is a separate CGT asset if:

A contract for the construction was entered into on or after 20 September 1985; or
If no contract, construction commenced on or after 20 September 1985.

Where farmland acquired on or after 20 September 1985 (post-CGT farmland ) is to adjacent pre-GGT farmland , the post-CGT farmland is taken to be a separate CGT asset if it is amalgamated with the pre-CGT farmland into the one title;

A capital improvement made to a CGT asset (e.g. farmland) that was acquired pre-CGT is taken to be a separate CGT asset if the cost base of the capital improvement (plus any related improvements) when the CGT sale happens exceeds both :

The improvements threshold for the income year in which the CGT improvement happened (e.g. the 'improvement threshold' for the 2018 income year is $147,582 and this threshold is calculated yearly by the ATO); and

5% of the capital proceeds of the CGT event.

What happens when a "separate CGT asset" on pre-CGT farmland is
sold?

In any of the above scenarios, when the farmland is sold, the sale if effectively treated as a disposal of two or more CGT assets, and the following CGT consequences will arise:

any capital gain or loss arising in respect of the underlying pre-CGT farmland will be exempt (i.e. the farmland the structure sits on remains a pre-CGT asset); and

any capital gain or loss arising in respect of any separate CGT assets (i.e. buildings, adjacent land and/or capital improvements acquired on or after 20 September 1985) will be subject to CGT.

Apportioning proceeds on sale of a "separate CGT asset"

When dealing with separate CGT assets, the CGT rules require the capital proceeds received upon the sale of farmland to be apportioned on a reasonable basis between the pre-CGT underlying farmland and the post-CGT buildings/land/improvements. A 1998 tax determination stated that an apportionment based on market values at the time of sale is generally acceptable as "reasonable".

Example – Capital improvements made to pre-CGT land treated as a separate CGT asset

Susan acquired farmland in the 1970s for $100,000. From that time, the farmland was used in a horse breeding business carried on by a related company.

This farmland is pre-CGT farmland as it was acquired pre-20 September 1985 and, ordinarily, would not be subject to CGT when sold.

The company's farming operations ceased during the 2015 income year, and capital improvements to the farmland were made during the 2016 income year to ready the farmland for sale. The improvements, costing a total of $260,000, included clearing the land, engaging contractors to upgrade the electricity connections and sewerage works, and rezoning the land for mixed property use.

Susan sold the farmland in the 2018 income year for $2 million dollars, and it is considered to be the mere realisation of an asset (i.e. not a "profit-making" venture).

Are the capital improvements "separate CGT assets"?

Yes. These capital improvements will be separate CGT assets, as the total cost base of the related capital improvements (i.e. $260,000) exceeds both :

The improvements threshold for the income year in which the CGT improvement happened (e.g. the 'improvement threshold' for the 2018 income year is $147,582); and

5% of the capital proceeds of the CGT event (i.e. 5% of $2 million = $100,000).




The capital proceeds of $2 million need to be apportioned, on a reasonable basis, between the pre-CGT farmland and the post-CGT capital improvements to the land. For example, if the market value of the farmland at the time of the CGT sale would have been $1.5 million had the improvements not been made, it would be reasonable to attribute $500,000 (i.e. $2 million less $1.5 million) of the capital proceeds to the post-CGT capital improvements.

Accordingly, the capital gain on that separate CGT asset is $500,000 less the relevant CGT cost base items. As the improvements were held for at least 12 months, a 50% general CGT discount applies to this gain.

Note - if Susan is eligible, any capital gain may be reduced under the CGT small business concessions .

Please don't hesitate to contact the writer if you wish for me to clarify or expand on any of the matters raised in this article.

DISCLAIMER

Any reader intending to apply the information in this article to practical circumstances should independently verify their interpretation and the information's applicability to their circumstances with an accountant or adviser specialising in this area.

By Paul Carrazzo (CPA) from Carrazzo Consulting CPAs.