Dissolving strata title and the potential for capital gains tax (CGT) liability
Although still uncommon, dissolving strata titles is becoming more prevalent with the rise in the number of high net worth individuals who own many properties. This paper points out the potential for capital gains tax liability to be imposed on the owners of lots in a strata title that is dissolved. In order to illustrate this, it is necessary first to explain the history of strata titling and the creation of a strata title.
History and creation of strata title
Before strata titling was introduced, blocks of units were usually owned by one of two methods – company title or tenants in common.
Company title is where a company owns the building and, by owning shares in that company, entities are entitled to occupy a particular unit.
Tenants in common is where all tenants in common have a right to possession of the whole property. However, legal documents would be in place to entitle entities to occupy particular units.
Neither of the above methods of ownership conferred separate ownership on the entities involved and it was harder to obtain finance to purchase units.
Accordingly, the Conveyancing (Strata Titles) Act 1961 (NSW) came into effect on 28 July 1961. The first building in the world to be strata titled was a block of 18 units in Burwood, Sydney, in July 1961. Now there are numerous strata title buildings.
What happens when a building is converted to strata title?
Under strata title, entities own their respective lots (the airspace inside their unit and interior walls) and jointly own the common property, comprising the external walls, ceiling and floor and all other parts of the land and building, excluding the lots.
When a building owned under one of the previous ownership methods is converted into strata title, the following is effected:
- Each owner disposes of their interests in all the other lots except the one corresponding to the unit they occupy
- Each owner acquires the whole interest in the lot corresponding to the unit they occupy from all the other owners
This transfer of interests between the joint owners is known as “partitioning”.
Ability of taxpayers to use “roll-over” to delay CGT liability
As each owner is disposing of a capital gains tax (CGT) asset, on creation of strata title, CGT event A1 is triggered.
However, section 124.190 of the Income Tax Assessment Act 1997 (“the Act”) provides for a roll-over in this situation, meaning that the liability for CGT can be rolled forward until the next CGT event, if the stratum unit transferred to an entity after strata titling corresponds to the unit they had a right to occupy before strata titling.
Accordingly, on creation of the strata title, if a taxpayer elects to use this roll-over, they will not be liable for CGT.
Example – tenants in common convert property to strata title
Lee and Chris own a parcel of land with a block of two units built on it as tenants in common in equal shares. They have an agreement that Lee can occupy unit 1 and Chris can occupy unit 2. They decide to convert the property to strata title so that each of them has ownership of their newly created respective lots 1 and 2 respectively, corresponding to the units they occupy, and share ownership of the remainder common property through the owners’ corporation.
The effect of this conversion to strata title is as follows:
- Lee is disposing of an interest in lot 2 (that corresponds to the unit occupied by Chris) and Chris is acquiring that interest; and
- Chris is disposing of an interest in lot 1 (that corresponds to the unit occupied by Lee) and Lee is acquiring that interest.
CGT event A1 is triggered for both Lee and Chris and they should both apply the roll-over under section 124.190 to avoid CGT liability.
Dissolving strata title makes owners tenants in common
A less common event is where a strata title is dissolved. One reason I have seen for doing this is that an individual owns all the units in a block, directly and indirectly, and wants to remove the body corporate.
Dissolving the strata title will convert the separate ownership of lots into a joint ownership of the building by the former lot owners as tenants in common. This is akin to the reverse of a “partitioning” as described above.
Accordingly, the effect of dissolving the strata title is that each owner acquires an interest in all the lots of the other owners from those respective owners. Simultaneously, each owner disposes of partial interests in their lot to all the other lot owners.
CGT roll-over not available when strata title is dissolved
This again triggers CGT event A1 as a disposal of a CGT asset. However, the Act does not provide for a roll-over in this situation. I expect this is because it is an uncommon event and is not yet covered by legislation. Accordingly, the lot owners would potentially be liable to pay CGT unless they were all owned by the one entity directly.
It is worth noting that this is a technical argument and capital gains tax liability may not be pursued by the Commissioner of Taxation in this situation. However, it would be prudent to take note that if you want to dissolve a strata title and you own the units in the building through different entities, there is a risk that you will be required to pay CGT.
If anyone has questions or comments regarding this, please feel free to contact me.