Tax Tip 204: Better to claim an expense off income rather than CGT?

Generally, it is better to claim an expense against the income it relates to in the year it is incurred compared to claiming it against the CGT when the asset is sold. There are 2 reasons

a) A benefit is quickly obtained rather than waiting for many years until the sale, and

b) The 50% CGT discount erodes the benefit



Example 1

Bart buys an investment property and uses redraw to pay for the deposit. He doesn’t realise that he can claim the interest on the redrawn amount from his main residence loan. This amounts to $2,000 per year.

Bart’s mate Barney says don’t worry; you can claim it when you sell – which is technically correct. But…

a) Claiming $2,000 could mean Bart has an extra $1,000 in his pocket – or better yet he can use it to pay down debt and save interest.

b) When Bart eventually does sell any capital gains will be reduced by 50% (assuming he sells more than 12 months later) and this means he is at best only getting a $1,000 ‘deduction’ which might save him $500 at most



But in some cases, it is better not the claim an expense when it is incurred if there will be no income tax advantage.



Example

Lisa has a few properties and then takes a year off work because of a baby birth. Without claiming any expense, his taxable income will be $20,000, but if she claims all the expenses it will be a taxable income of $1,000.

The tax on $20,000 is nil, the same as the tax on $1,000 so there is no advantage in claiming expenses.

If Lisa doesn’t claim them she can claim them off the capital gains when the property is eventually sold – she will be actually better off if he does this as it could result in a capital gain which is $19,000 less than it would have been, or $9,500 less after the 50% CGT discount. This could save her about $4,000 at that point.

 

Its also poorly understood the revenue losses can be used to offset a CGT profit. The discounted gain will be part of assessable income THEN the tax loss offsets that.

Some issues can occur with carried fwd losses:
- They MUST be applied to every dollar of taxable income, not just to bring you down to $0 tax.
- They can be used to offset a CGT taxable gain (as CGT gains are a element of taxable income)
- Wont assist or impact a CGT loss. A CGT loss is carried forward to offsets future CGT gains (BUT...Before a discount is applied)

 

Actually it may not be possible to claim expenses off capital gains when sold if you COULD have claimed those expenses off income. This is because :

s110-55(4) ITAA97 has the words 'could have deducted' in it so as it would exclude interest that hasn't been claimed but could have been claimed against income.

Check with your tax advisor.

 

i dont believe you can

section 110-45 also says " (1B) Expenditure does not form part of the second or third element of the cost base to the extent that you have deducted or can deduct it."

you CAN deduct it. you have CHOSEN not to. This is the same logic applied to in the Practice Statement on Capital Works the ATO has issued.

 

But the words 'can deduct' would apply only up to the end of the tax return amendment period. After this it would no longer be possible to deduct.

However, s110-55 says:
(4) The reduced cost base does not include an amount to the extent that you have deducted or can deduct it (including because of a balancing adjustment) or could have deducted apart from paragraph 43-70(2)(h).

So the reduced cost base would not include interest that was deductible but was not actually claimed.

But the question now is what is 'reduced cost base' and when does it apply?

 

reduced cost base relevant for a capital loss

BUT read section 110-45 and what ATO view is on "can deduct it". They express their view on the definiton of "can deduct it" in PS LA 2006/1 which deals with capital works but indicates their position on that particular wording

I cannot see how PART IVA would not apply even if "can deduct it" means out of time to amend. why else have you done it ?

 

I think there is an arguable case, but each taxpayer should get their own specific advice on this strategy before implementing.
The trouble is those earning less than $20k are not likely to want to pay for that advice.

 

Is probably more like it!

 

exactly. i disagree and i would never recommend this strategy. but the amount of people it would affect makes it a mental masturbation exercise.

 

Found something to support my position
TD 2005/47

11. Sybil is not required to reduce the cost base of the property by the amounts that she did not deduct under Division 43 of the ITAA 1997 for the income years ended 30 June 1998-2000, as she cannot deduct these amounts at the time of lodging her income tax return for the income year ended 30 June 2004 - the time periods prescribed for amending assessments for those income years having then expired.

Legal Database

 

Watching this thread with interest as could potentially apply to a cash flow play owned by low income earning spouse.
Thanks all

 

@craigc Terry and I have discussed this. We both believe given that Part IVA would potentially apply to the proposal. proceeding without obtaining a Private Binding Ruling would be most unwise.

 

If there is no difference in income tax now whether you claim costs or not then it might be best not to claim, as there is no harm done, and then consider whether to include these costs in cost base expenses at the point of sale.

 

Before trying this at home make sure you do get tax advice as it may not be possible to use 3rd element costs to reduce CGT in situations like this.