Depreciation is added to Capital Gains at time of sale?

I am reading this article which is saying that for investment properties the amount of Depreciation is added to Capital Gains amount at time of sale. Is this correct?

Investment apartments: Is claiming depreciation worth it in the long run

 

In a very basic sense yes, because depreciation lowers the cost base of the asset.

I mean it makes sense why that happens right?

 

There are two ways to perform the reduced costbase calculation.

1. The total sum basis. Addback all deduction claims or
2. The adjustmnet to the sale proceeds basis. Think of the property sale as a sale of two elements. One is a disposal for nil profit or loss of the written down value of the depreciable element. eg Assume a single AC unit. It has a WDV in the QS report of $8323. The AC originally cost $12K. In that case deduct $8323 from the sale value used for CGT calcs. This is because plant items are not a part of the CGT asset being disposed.

Always ensure however that any assets subject to adjustment are included in the costbase. If the QS did a appraisal of the property all is OK. However ensure you ADD to the costbase (to reduce CGT) for the cost of the asset if you purchased aftre the acquisition date. That addition of the $10K and the reduction of $3677 that has been claimed over time will achieve the same number as the total sum basis. You will be suprised how often this is missed !! Its like paying tax on 50% x $12K being the AC cost.

 

The way I try to explain it to people--investors and new colleagues alike--is that claiming depreciation pulls value out of the property so that you can claim a tax advantage now, therefore lowering the cost base. Capital improvements put value back into the property, raising it the cost base.

It's important not to forget that a.) the 50% CGT discount usually means a substantial overall benefit to claiming depreciation, regardless of any add-back, and b.) claiming depreciation gives you cash flow: money you can actually do something with. Though, that's general comment and not tax advice--results may vary in certain scenarios.

 

I did a media article with a journo this week. In short "You will be at least 50% better off. Unless otherwise advised, a taxpayer is always better off by claiming as much depreciation as possible as a cashflow and a tax benefit. ".... There is a execption that didnt go to print. That is people who become non-resident and the property is a former home. They may get no 50% benefit and their only benefit is just enhanced cashflow that is recouped on sale. Think of it as a interest free loan. Thats pretty rare.

I like the capital improvements view. I will keep that.
However ïmprovements may fall into a range of situations
1. Some may be deductible where they repair defects. That has to assist a sale price AND its also deductible.
2. Then much is not deductible but may enhance depreciation AND value when sold.

 

I just encountered the laws specific to this issue.

s40-295(1) ITAA97 refers to the need for balancing adjustments when a div 40 asset (which is part of the property being sold) is disposed. The balancing adjustment affects the portion of proceeds for the CGT event that remains. Further s118.24 ITAA97 also excludes any CGT gain or loss from such events to avoid and address potential duplication.

 

The way I look at it is that $1 in depreciation today is way more valuable than adding $1 back to the cost base in 10, 20, 30, … years time if/when I sell

 

Deduct today at your marginal rate.
Pay cgt at half your marginal rate in the future. IF you sell.

 

If I inherited a property from my grandparents and this has been an IP for them for 10 years and after holding this IP for 5 years, say I decide to sell it. How will I be able to work out the depreciation their accountant had claimed whilst it was an IP for my grandparents? Or is the cost base worked out to be value when I inherited it, take away the depreciation I claimed for 5 years?

 

You dont need to adjust for their depreciation. You inherit their costbase (not their reduced costbase) at the time of the death and the add back doesnt impact you. If they both owned it and unless they die together then its likley you have two elements...His and hers. Why is this a exception...For the very reason you ask. Few people will know what someone else claimed. And it may depend too what date theey aquired it...If any is pre-CGT itcould even be simple to determine that market value at the date of that persons death.