Insurance - cash payment - tax implications

Discussion in 'Accounting & Tax' started by RENI99, 15th Apr, 2020.

Join Australia's most dynamic and respected property investment community
Tags:
  1. RENI99

    RENI99 Active Member

    Joined:
    17th Nov, 2019
    Posts:
    40
    Location:
    Bribie Island
    Hi
    We received a cash settlement for an insurance claim on our investment property following water damage to a bathroom. The bathroom had to be rebuilt - including repairs to the structure (above a garage with damaged beams) and we made some improvements as part of the renovations - e.g. replaced vanity/tapwear and changed shower to a walk in. We used the same type of tiles and did not change the format of the bathroom.

    Our accountant advised that the cash settlement should be declared as income and because of the nature of the works the cost of the rebuild would need to be depreciated. So not an ideal outcome from a tax perspective.

    We took the cash settlement as we wanted to use our own builder after previous negative experience with insurance company builders.

    Looking for advice to confirm that this is the appropriate way to handle and if any other alternatives.

    Should cash settlements be avoided because of this or at least if it is a cash settlement ensure that the works are repair to existing and not any improvements?. Or perhaps the work can be split?

    I have read the ato section on repairs after a disaster - assume that this is the same application although not a "disaster" event as such. - Rental properties and business premises

    thanks
     
  2. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

    Joined:
    18th Jun, 2015
    Posts:
    15,124
    Location:
    Sydney
    It would be assessable income unless there is a eligible replacement asset rollover within 2 years (generally dwelling for dwelling !) or deductible outgoing. If you had a QS report it may be worthwhile seeking QS re-review of the damage up so they can assess the value of building works to be scrapped.

    A QS probably should assess images to identify the extent of damage and deductions as there is an evident repair. BUT a blended invoice from a single provide wont help. Cheaper option is to seek a binding private ruling incl prior and after images etc that demonstrates damage and works taken to restore to its original condition. Unfortunately a replacement isnt always a write off but if its a repair its more likley to use similiar materials to avoid a complete replacement.

    and we made some improvements as part of the renovations - e.g. replaced vanity/tapwear and changed shower to a walk in - This doesnt help. It may be blended as one cost.
     
  3. NedKelly

    NedKelly Well-Known Member

    Joined:
    3rd Aug, 2015
    Posts:
    112
    Location:
    Gold Coast
    I have just returned from my accountant with a similar issue, except it is a fixture. My rental was trashed by the tenant and I received a payout of over $14,000. My accountant has put this down as income and there are some items that I replaced like the air conditioner which was perfectly serviceable before being trashed and cost $3,300 to replace. This has been added to the asset depreciation schedule and I get a $321 a year deduction but have to pay tax on $3,300. So the result is I have to pay tax on the $3,300 at 32.5% less a $321 deduction. This seems totally unfair, is it correct?
     
  4. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

    Joined:
    18th Jun, 2015
    Posts:
    15,124
    Location:
    Sydney
    Insurance gives rise to a reimburseable adjustment. If the loss can be quantified as a repair, cleaning, or scrapping there may be a deductible element against the income. If the income includes lost rent then is a element of rental income too. Yes it may give rise to a assessable amount. I hope the tax agent scrapped assets destroyed. eg old AC. carpets etc Did you have a QS assess the residual cost of the damage to the building. That is likely a repair cost not a new asset. Walls are part of the building and you didnt replace the building by fixing the walls. Its a repair of damage. Pics may assist the QS. I always suggest getting the QS in before making major repairs like that. The QS may be able to assess the cost of the repair element performed by the insurer v that of non-repairs.

    In respect of the AC you cant deduct new capital expenditure. It is depreciated. The old one could be written off unless its now being pooled or has $0 value left.

    If a rental property is destroyed by a tenant it could produce a similiar problem. eg $400K insuarnce payout for total loss. Lets assume $30K is lost rent and $370K is for the building. The $30k is assessable as rent. There may be a scrapping deduction for the residual Div 43 and Div 40 and thats about it. There is a rollover provision that allows any profit to defer into the costbase of a replacement house that is then constructed but a time limit applies. I have seen several clients face a costly tax amount due to property destruction. It is not a CGT event eligible for exemption as some people are told. A house is a deprecaible asset and their destruction means the difference between what the insurer pays and what is written off is taxed. eg scrapping on house is $144K. $370K less $10K site clearing costs less $144k scrapping could be a $216,000 tax problem.
     
    qak likes this.
  5. NedKelly

    NedKelly Well-Known Member

    Joined:
    3rd Aug, 2015
    Posts:
    112
    Location:
    Gold Coast
    Thanks Paul. Your last sentence about scrapping a house is a worry. I suppose the same would be true if the tenants set fire to it.
     
  6. RENI99

    RENI99 Active Member

    Joined:
    17th Nov, 2019
    Posts:
    40
    Location:
    Bribie Island
    In the end after a lot more research and advice from taxation experts (managed by our accountant) we did not declare the insurance payment as assessable income nor did we claim any deduction for the works (or any future depreciation). This was because the asset was destroyed and returned to its prior state and it was a Capital works asset. Some of the advice included.
    1. The composition of the insurance proceeds must be assessed to determine the portion relating to replacing a Division 40 asset (depreciating asset) and replacing a Division 43 asset (capital works).

    2. Where there are proceeds pertaining to replacing a Division 40 asset, a balancing adjustment occurs and the difference between the closing written-down value of the Division 40 asset and the insurance proceed amount is essentially assessable.

    3. Where there are proceeds pertaining to replacing a Division 43 asset, a deduction is allowed under s. 43-40 for the taxpayer’s previously undeducted construction expenditure in relation to that area. Separately, there is an assessable amount under CGT event C1 where the insurance payout amount exceeds the costs to rebuild (i.e. excess amount over rebuild costs are assessable). However, in your scenario, the insurance payout amount is equal to the build costs and therefore, no amount is assessable. At the same time, no amount would be deductible in relation to the build costs.
    There was also an example

    "John purchased a rental property. The property was available for rent upon settlement and John has claimed rental property expenses since that time.

    A flood occurred and damaged the property.

    John received insurance payouts which were used for repairing and replacing damaged areas of the property — i.e. the payments related to repairs (s. 25-10) and capital works (Div 43).

    The repair work was completed, and the property was re-let.

    Implications
    •  Repairs — as the requirements of s. 20-20(2) are met, i.e. John received an insurance payout to cover the cost of repairs which were deductible under s. 25-10, the amount of the payout which relates to the deductible repairs must be included in his assessable income.

    •  Capital works — under s. 20-20(2)(b), recoupment of a loss or outgoing is only an assessable recoupment if the taxpayer can deduct an amount for the loss or outgoing in the current, or an earlier, income year.

      While John may be able to deduct an amount in in relation to the original construction of the capital works under s. 43-40, or in relation to a future construction of replacement capital works under s. 43-10, these are not deductions for the loss referred to in s. 20-20(2)(b), and no outright deduction is available for the loss of the capital works.

      Accordingly, any insurance payout that relates to the capital works of John’s rental property is not an assessable recoupment under section 20-20 of the ITAA 1997. Such amounts are not assessable under any other provision of the ITAA 1997.

      Source: Based on ATO ID 2011/82 and PBR 1051422867111
      ===========================End Example============
     
    qak likes this.
  7. Ryan23

    Ryan23 Well-Known Member

    Joined:
    16th May, 2016
    Posts:
    176
    Location:
    Queensland
    *edit - I just saw your last post that references the same ATO interpretive decision that I posted. Although I do note that the decision was withdrawn in March this year*

    This was an interesting decision that I found a couple of years ago when dealing with a similar incident. From what I gathered, if you couldn’t deduct against the insurance payout in the current year, it was not assessable income and went to the capital basis. However the decision was withdrawn last month. Don't know what the new ruling is.

    https://www.ato.gov.au/law/view/document?docid="AID/AID201182/00001"
     
  8. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

    Joined:
    18th Jun, 2015
    Posts:
    15,124
    Location:
    Sydney
    There is a difference between an assessable recoupment and a insurer settling a claim with a insured party where the proceeds are expected to be used to remedy defects subject to the claim. That decision etc is a edited portion. eg John receives the proceeds and doesnt use them to remedy defects etc. Or only some of them. He later demolishes the dwelling to rebuild. The former test was as @Ryan23 puts it - If you cant deduct the loss then the receipt element that relates to it is not assessable. Each settlement can vary. Insurers often pay insured parties for assessed loss and wont initiate repairs as other non insured defects must first be remedied etc. The fact the insurer paid the insured is akin to the position if the insurer had conducted the repairs themself which doesnt produce any deduction or assessable event either. ie Non-assessable etc. But each paymnet must be considered and until it has the taxpayer cannot assume it is not assessable. eg It may include a element for lost rental income.
     
    Ryan23 and qak like this.