Insurance Proceeds from storms, flood etc

The past two years have been bad for weather events in large areas of the counrty.

Its possible to make some major mistakes with how you treat insurance payouts etc. This post inst intended to be a definitive answer but I wanted to address the key basics so mistakes could be avoided.

What did you receive insurance proceeds for ?
Was it for lost income, damage to the property or its partial or complete destruction ? Sometimes the payout could be one issue, could be several. These issues are important.

1. Payment for lost rent will be assessable. The payout IS akin to rent. And if its received early thats unfortunate since the assessable point is the receipt. The excess loss is ignored. You cant claim a deduction for a cost for something which isnt received. The lesser assessable is the amount the insurer pays.
2. Complete destruction means the insurance proceeds is probably CAPITAL in nature. This will have a impact on the CGT costbase but the proceeds are not likely to be assessable as such
3. Partial destruction and damage may give rise to tax events

Proceeds received for damage
The assessable recoupment rules kick in here rather than taxable income rules. This is important. lets say the insurer pays the owner for damage to the property and they dont conduct the repairs - Lets say they personally fix it for no cost. Then there is no deduction for outgoings so theye is no assessable amount. eg Fred owns a coastal QLD property whch loses part of its roof. The insurer pays $5,000. Fred fixes the roof for $100. Fred knows about the assessable recoupmnet rules and doesnt chase a deduction. Then the $5K is not assessable.

Lets put Fred aside and explore the common issue that the INSURER repairs the damage. Then the owner may only have a deductible outgoing being the excess they have paid. The damage is repaired by the insurere and no further deductions are allowed. There is no effect on quantity surveyor deductions as there is no outgoing. Insurance "reinstates" the property condition. The cost of repairs will not add to the costbase as there is no cost.

Commonly the taxpayer will include in assessable income the claim amount (or the part of it for the damage) AND will also claim a deduction for their own expenditure to repair the damage. Damaged building issues will generally be deductible as the building is not DESTROYED. If the proceeds from the insurer are far higher or far lower than costs the taxpayer could face a tax consequence.

Insurance proceeds received for damaged depreciable items wont usually result in balancing adjustments (scrapping) as any expense is a deductible repair and the asset still exists. Depreciation continues. Scrapping may apply when these assets are destroyed. The insurance proceeds for the loss must be considered. Its possible a assessable or deductible amount arises. eg A fridge is destroyed in a flood. The book value is $100. The insurer pays $200. $100 profit is assessable.

Proceeds received for partial destruction
This will not be assessable unless a deductible outgoing is incurred - The assessable recoupment rule

CGT costbase impacts
Property damage doesnt usually trigger any CGT event. However sometimes the costbase itself can be impacted;
- Non-deductible maintenance (Fred and his $100) will increase the costbase
- Deductible repairs will NOT increase the costbase
- New installed plant items (eg carpet, kitchen appliances, cabinets etc) will increase the costbase and are not deductible as repairs. Over time they may become depreciable and can often be addressed by the tax adviser rather than a updated QS report. However sometimes a updated QS report may be better
- The costbase will be REDUCED by the non-assessable proceeds received for partial destruction of the building. To the extent the costbase remains at least $1 then no CGT event occurs. If the insurance proceeds received for damage exceed the costbase CGT event C1 may occur. Tax advice is wise. This is quite unusual for DAMAGED property. It is more common for complete destruction.
- When considering CGT impacts of partial and complete destruction a deduction for scrapping for the building should be explored. A Quantity Surveyor may need to assess the partial destruction amount but for complete destruction a existing quantity surveyor report (and any tax return schedules) may suffice. The reduced costbase and any scrapping may impact a CGT calc and the costbase.
- CGT matters may be impacted by any rebuilt asset, replacement asset etc. However, this excludes the land element. It is further unlikely land is destroyed.

Sound complex ? Yes it can be. This is why competent property tax advice is wise. It may identify tax benefits such as non-assessable amounts, scrapping or other issues

 

This is really interesting.Thank you for posting this.

We will be facing this scenario soon I think following the NSW flood.

We have just been paid out a lump sum for the 52 weeks rent we are entitled to. Judging by your post will be assessable? Classed as income?

Re: the damage to the property, a cash settlement should be finalised in the coming weeks. Although it's fixable, we are not planning to fix the damage, but plan to take the payout and then sell the property as is at as reduced amount.

Any suggestions, considerations and advice you have on this would be gratefully received.

Thank you.

 

If the payment is to cover lost rent it would be assessable income and subject to tax in the period it is received. If the premises are sold damaged then a CGT loss may be more likely to result. The two dont offset which can affect overall tax payable. Deferred timing of sale may not assist either

If a damaged property stops producing income then the deductions may cease when the period of the insurance proceeds for lost rent end and in some cases, earlier. Costs to preserve ownership to sell may become CGT costs which increase a CGT loss rather than produce deductions.

The costbase of the property (or building or plant) being sold may need to be adjusted if the insurer pays proceeds to address damage and this is not rectified. eg TR 95/35 addresses assessable recoupments which may lower the costbase but not beyond $Nil

 

Hmmmm....... All very technical, but I think I am getting........ Some of it......

- insurance payout for rent is assessable as income at tax time.

I'm confused on the following:
Firstly some background:

We bought the units for $270,000 6 years ago. We were going to sell just before the flood. It was valued at $440,000 by real estate agents.
The floods then hit. Insurers put the cost of repairs at $300,000.
Agents believe we can sell the land as is (without repairing the buildings) at about $300,000.

Questions:

- if we sell the land for 300,000, is there then CGT loss of $150,000 from the value of the land prior to the floods since repairs to the property have NOT been done?
Or
Is there a Capital Gain from the original 270k purchase price?

- if we don't do work on the units and therefore don't declare the work done as a deduction at tax time, is the 300,000 cash payout still assessible?
Or
Is the 300,000 cash payment an added captial gain of the property? If we sell the land for say 300k, do we have to add the cash payout and the sold land price together (600k) and work out capital gain from there?

Trying to work out what is the best strategic approach would be tax wise.

 

You require tax advice. I wont answer the question here as it is complex. Insurance proceeds may reduce the costbase and lead to changed CGT outcomes. The $300K is unlikely to be assessable as such BUT affects the CGT outcomes. As may any prior depreciation or capital allowance etc

 

Ok.
Really appreciate your information. Really interesting.
Thank you

 

We are in the same situation. We have received loss of rent cover which I understand will be taxable but we have also received a payout for damage.

the damages payout is in the vicinity of 50k which is obviously a reasonable tax burden come end of year. Our accountant advised the payment for damages WOULD be taxable. We did repairs similar to your situation for Fred. Are they incorrect in that it is NOT assessable income for the damages payout? In Fred’s situation if he claimed a deduction for the $100 does that then make his 5k payout taxable? What if Fred had already claimed some deductions for some repairs in the prior years tax?

Similarly I have an income protection payment with an older policy that was paid out in a lump sum for fracturing my radius BUT I could keep working ie. It was kind of like a trauma component of an income protection policy. I have been claiming a deduction for the policy premium each year since I have had it so I take it this means it is assessable income even though it is a trauma-like payout
Thanks heaps

 

I dont share their view. Its necesary to consider if the insurance is to replace income, repair damage or compensate for destruction. It may encompass all three and details may be important.

s20-20 ITAA97 governs assessable recoupments. if
1. received by way or insurance AND
2. An amount was deductible for the loss or outgong in the current or prior years (eg You paid a builder to make repairs and the cost was deducted as a repair)
then the receipt is assessable.

If it falls outside this its possible the receipt is non-assessable and may merely affect the CGT costbase. eg John had a deck washed away by flood water. He received $4900 from the insurer and did not replace it. In that case as John cant determine how much of the building was damaged and made no repair he must apply the insurance proceeds to reduce the CGT costbase. The $4900 of insurance in not assesssable.

Compensation for a trauma policy is uncertain. It would be wise to seek a private ruling including details of the policy and payout. If it was compensation for injury and not for lost income its highly possible it is not assessable. It may be a add on to the deductible income protection policy and not assessable as such. This can occur with some policies where the annual premium is only partly deductible since the trauma policy premum is not deductible. A binding ruling would avoid error and ommission

 

Hmm… so we claimed around 7k in repairs last financial year but received ~50k for damages alone (not including the rent cover). Should we consider putting in an amendment for last years tax return to remove the 7k deduction as this would be financially much better off for us not to claim a deduction in order to not make the 50k assessable. Wish they had advised us of this so we hadn’t included this in our return. Alternatively could that mean that only the 7k is assessable which would be more easy to stomach. Will get in contact with them.

will also ask for a private ruling for the income protection
Thankyou

 

I would start with competent property tax advice to determine the breakdown of the $50K received and the nature of the outgoing. They may not have been provided the right information. Or asked for it. Or made a error. Detection and correction is the right remedy.

The assessable test is not an actual deduction. It is making the repairs. I would find it unusual to have a insurer pay you $50K and only $7k of expenses are incurred. Perhaps they paid $9K and it then cost $7K. Thats fine but then only a net $2K may be assessable not $50K. Insurers will not pay $50K for $7K of expected damage so something doesnt look quite right. The break down of WHAT they paid is relevant. I would be asking for that information from the insurer. There is time to amend and the ATO will pay (assessable) interest if its a favourable amendment.

 

I should say that the 7k is the only deduction we have claimed thus far (on last years tax return). The 50k payment only came through this financial year as it took a long time to come through but we still need to organise/pay for further repairs. Thanks heaps

 

Hi Paul,

Do you mind if I email you in the hope arranging an official "meet" with my wife and I to get some tax advice on this.

Thank you.

 

Hi there Jobeki,

Just wondering how things developed for you after the insurance payout. What tax implications did you face?

All the best.
Hudbry