Div 40 Depreciation - Changed Use

Have encountered a recent query I thought I would share.

Taxpayer has acquired a new apartment OTP. They did not occupy the property but rented 2 of 3 bedrooms and each occupant has shared use of all living areas. Aftre 6 months the owner plans to occupy the property for several weeks or even months then vacate it and rent the third room.

Question ? What happens to the QS deductions for the 1/3rd ? Does it remain deductible or is the asset now used ? Is the QS report still correct or may it need to be corrected and deferred tax recognised ?

I will share the ATO view at a later time.

 

The explanatory memorandum may give people a clue

Example 2.2: Assets installed in new residential premises

Hannah purchases two apartments off the plan from Developer Co. The apartments are supplied three months after completion – one is already tenanted and the other is vacant.

In addition to the construction of the apartments, Developer Co has fitted out the apartments, installing ready for use depreciating assets including curtains and furniture prior to settlement and the transfer of the title to Hannah. Developer Co has also fitted out the shared areas of the complex in which the apartment is located, installing ready for use a range of deprecating assets that are the joint property of the apartment owners.

All of these assets are new at the time of installation. As these assets were first installed by Developer Co, not Hannah, they are previously used and a deduction would not be available under the general rules established by these amendments.

However, a deduction is still available to Hannah for the depreciating assets (including Hannah’s share of the assets installed in the shared areas of the apartment) for the period she holds the assets as:

• the assets have been installed ready for use in premises that were supplied to Hannah as new residential premises or in other real property supplied as part of the supply of residential premises;

• Developer Co has not claimed any deduction for the decline in value of the assets (and nor has any other entity); and

• either (excluding assets installed in the common property):

– for assets in the first apartment, the assets were only used or installed in the apartment, which was supplied to Hannah as new residential premises within six months of the apartment first becoming residential premises; or

– for assets in the second apartment, no entity has resided in residential premises in which the assets have been installed before Hannah held the assets.

Exception for certain entities
2.54 The reduction in the amount that can be deducted also does not apply to deductions incurred by an entity for an income year in which the entity is:

• a corporate tax entity;

• a superannuation plan that is not a self managed superannuation fund;

• a public unit trust (within the meaning of section 102P of the ITAA 1936);

• a managed investment trust

 

Ahh...But in this case the owner had new assets and they have been (partly used) to produce income and then partly (?) used by the owner until she vacates. Which test applies to the "partly" used element after the owner vacates ?

Hint - The ATO have refused a ruling since its a matter of what the law describes. There is a loophole in the law. It opens a strategy I hadnt considered before.

 

By "several weeks", I assume you're talking more than four, which is our interpretation of more than incidental or occasional.

And are bedrooms 1 and 2 ongoing rentals while the owner is living in the third?

 

Yes
Yes

 

The ATO response confimed that the depreciable plant items would not be impacted by the changed use. The issue is explained in a piecemeal approach in the 2019 Rental Property Guide (Pages 13, 21+) and the new legislation making it somewhat of a chore for most taxpayers.

s40-27 of ITAA contains the new provisions which look at the asset and whether it is a used asset. This test applies when the depreciable asset is ACQUIRED and installed rather than applying a continued use test as such. Subsequent personal use OTHER THAN WHOLLY PRIVATE use is governed by this element of the law. Wholly private use terminates the test of use of the asset and reuse at a later date then applies s40-27 at that time of second income producing use and no deduction would be allowed.

So the lesson in this is that the use test wont end unless the income producing use wholly ends.

Strategy : Peter and Tinkerbell own a apartment that was acquired OTP in July 2018. They immediately tenant it. After 2 years they are considering moving back in but only for 6 months but they have concerns they will lose their Div 40 deductions if they do this. Instead they allow one tenant to stay and tenant one bedroom for the 6 months while they live there. During this time they must apportion the Div 40 and Div 43 deductions for this shared use. After they move out the full depreciation deductions revert.

 

But they miss out on the use of the 6 year rule on the whole property

 

It is one consideration. Yes and the costbase will be impacted by any depreciation and cap allowance actually claimed as a deduction. They may also find third element costs a benefit.

 

This has proved most interesting to us. We did of course seek advice on this after the rulings passed and our thinking was that the (more than occasional or incidental) use nullified any future claim on the assets, hence why I voted for option 1.

I've shown your explanation above to a few people here and they started to come around to it. One noted that it was quite out of character for the ATO to have such an open interpretation; our position (and that of those who advise us) is perhaps conservative partly because of this--or perhaps this is a loophole we all missed!

Because it's interpretive, we're most likely going to do what we usually do and defer to accountant advice, but of course we'll give our perspective on it when asked. Such decisions do not lie with us at the end of the day, though. It's also hard to say how things will actually pan out when (if) the ATO gets tested on this particular issue, so we may just have to wait and see.

Anyway, if anyone is interested, here were some of the comments following my distribution of Paul's answer, with crucial parts of the rulings in bold and quotes from colleagues in quotation marks:

ITAA 97 40.27 notes (d) at any time during the income year or an earlier income year, the asset was used, or installed ready for use, either:
(i) in residential premises that were one of your residences at that time; or
(ii) for a purpose that was not a *taxable purpose, and in a way that was not occasional.

"This is more to do with assets coming from your own home but if this is his residence for a period of time would that change the interpretation as it would now be applicable."

Referring to the Treasury Laws Amendment (Housing Tax Integrity) Bill 2017:

2.31 An asset is ‘previously used’ for an entity if:
• the entity is not the first entity that used the asset or installed the asset ready for use (within the meaning of Division 40) other than as trading stock;
• the asset is used or installed ready for use during any income year in premises that are, at that time, a residence of the entity; or
• the asset is used or installed ready for use during any income year for a purpose that is not a taxable purpose, other than incidental or occasional use.

2.20 The definition specifies that land or a building that meets these requirements is residential premises regardless of the term of the occupation or intended occupation. It also specifies that ‘residential premises’ includes a floating home.

2.35 For example, if an individual acquires a new apartment and uses it as their residence in an income year before renting it out, any assets used in the premises would generally have been used wholly for personal use or enjoyment during that income year. The individual would not subsequently be able to access any deductions for the decline in value of those assets while it is being rented out.

2.37 Whether residential premises are a person’s residence at a particular time is a question of fact requiring an examination of the person’s connection with and use of the premises. A dwelling an entity owns that is currently being rented out to a tenant is not generally a residence of the entity at that time, even if it had previously been a residence of the entity. On the other hand, a holiday home that is principally held available and ready for the use of an entity may well be the entity’s residence at that time.

"With this sentence it notes that if rented then not generally your residence and so the above from 40-27 (d) and 2.31 do not apply."

"In this unique scenario it wasn’t wholly used for private purposes at any point."

"It would only apply in a small number of circumstances. In many partial private use cases, our clients might have a house they’re already living in (or just purchased new and moved in at the same time as the tenant). Not many would be able to establish the property wholly being used for income producing purposes first."

 

Thanks for that.

IMO its important not to end the income producing use as this triggers the used asset rule when a subsequent use recommences. The wholly used for private purposes covers as a main residence OR vacant property of course. By vacant I dont mean between tenants. I mean you no longer rent it and its use is wholly private (eg used by family, vacant or even as a home etc)

One of the issues the ATO seemed to refer to is that an asset need not be wholly for one specific purpose. When it has a proportionate use for different purposes then one or more purpose may (each) represent a taxable purpose provided at least one taxable purpose is maintained. However when that stops the first limb then applies.

• the asset is used or installed ready for use during any income year in premises that are, at that time, a residence of the entity; or
• the asset is used or installed ready for use during any income year for a purpose that is not a taxable purpose, other than incidental or occasional use.

When I thnk more of it I think of a different example, lets say a car used by a sole trader. Div 40 looks at the income producing use and may require a private portion be adjusted. If the income producing use ends then the deduction ceases. But unlike this change it can recommence at a later time and perhaps for a different % of use. So when I think of it this way it sort of makes sense. I only came to consider the issue as a client asked the question and I had to admit I didnt know. Who bettre to ask than the ATO