Tax Tip 252: CGT and Depreciation of Plant and Equipment

Before CGT was not affected by the depreciation claims on plant and equipment or fixtures and fittings (Div 40), but this changed with the Budget of 2017 where the laws were changed to prevent the claiming of depreciation on second hand plant and equipment.


Where the property was purchased second hand, not brand new, now when an investment property is sold the plant and equipment needs to be taken into account with a balance adjustment calculation.

The unclaimed written down value is used to reduce CGT. Essentially a capital loss results from the plant and equipment.

This is known as CGT event K7, s 104-235 ITAA97
INCOME TAX ASSESSMENT ACT 1997 - SECT 104.235 Balancing adjustment events for depreciating assets and certain assets used for R&D: CGT event K7

Example

Homer buys an investment property in Aug 2018 for $500,000 and a quantity surveyor estimates the plant and equipment of that property to be worth $100,000.

2 years later Homer sells the property for $700,000. At this point the plant and equipment has deteriorated in value and is now worth just $70,000.

Since Homer has not been able to depreciate any of this plant and equipment by claiming it in his tax return (as it was not new), he can take this into account in working out the CGT.

The un-deducted value is $100,000 - $30,000 = $70,000


Homer’s capital gain is $700,000 - $500,000 = $200,000

(ignoring other cost base expenses such as stamp duty and buying/selling costs).


But the $70,000 can be deducted from this making the capital gain $130,000

Then the 50% discount is applied.


This is why you should still consider whether to get a quantity surveyor in when buying a property. However, it might not be needed where the property is to be held onto for 10+ years as the value of the plant and equipment at this point would be close to nil.

Happy to be corrected by @BMT or @Depreciator who are both tax agents and quantity surveyors and who specialise in this area (unlike me).


Relevant legislation

S 40-285 ITAA97 INCOME TAX ASSESSMENT ACT 1997 - SECT 40.285 Balancing adjustments

s 40-295 ITAA97 INCOME TAX ASSESSMENT ACT 1997 - SECT 40.295 Meaning of balancing adjustment event

 

See related post
Tax Tip 251: CGT and Building Depreciation Tax Tip 251: CGT and Building Depreciation

 

Thanks Terry,

Above you write "Before CGT was not affected by the depreciation claims on plant and equipment or fixtures and fittings (Div 40)"

Does this mean for properties that you acquired pre 2017, of which you're claiming decline in value on your yearly tax returns for items under Div40, there are no CGT implications at all for? I was of the understanding there are CGT implications for these items, but could be incorrect.

 

No.

The rules for Division 40 were impacted by the 8th May 2017 budget. It introduced changes to phase out Div 40 on certain assets. These include used assets acquire aftre that date (incl those ina new property acquired if it was no "new". An existing assets at 8th May 2018 are also affected if the USE of the property is not continual as a income producing property.

example :

Cartman acquired a property in 2010. He has a QS report and the property is rented until 12 August 2018. He moves in. Then five months later moves out to live with his mate Kyle. He rents the property out. The changes rules for Div 40 do not allow the former Div 40 in the QS to be claimed since the assets are now considered used by Cartmans own use of the asset. The Div stops BUT...The deduction he could have claimed will now be available as a CGT loss at the earlier of :
1. Scrapping of the specific asset or
2. Sale of the property

All taxpayers are impacted by the May 2017 change. Pre May 2017 assets must be continually used to produce income or the Div 40 ceases. Post May 2017 assets must also be continually used to produce income FROM NEW or they too will cease deductibility. A period of vacancy does not stop Div 40. However use of the property for a private purpose will terminate Div 40 for the future.

 

And the 'use of property for a private purpose' is what is going to trip up many owners of holiday homes. People with holiday homes depreciate the Assets e.g. appliances, floor coverings, furniture etc. If they use the property themselves (as many do), from that point on they cannot keep depreciating the Assets.

 

An asset will not be previously used if it has only occasionally been used for a purpose that is not a ‘taxable purpose’ within the meaning of Div 40.

Use for a purpose is ‘occasional’ where the use is infrequent, minor and irregular. For example, according to the EM, spending a weekend in a holiday home or allowing relatives to stay free of charge for one weekend in the holiday home that is usually used for rent would generally be considered ‘occasional’ use. Outside that there is no guidance and a private ruling would be suggested if a claim is being considered if there is use that is a more than TWO, maybe three nights. (A long weekend ?)

 

Yes, the lack of guidance is vexing. We had a client this week who said they have a holiday home and always stay there themselves from Christmas Eve till late January. I told them I thought this constituted more than an occasional use and I suggested they get a PR. I have a pretty good idea what the result will be.

 

I would save the time wasted applying for a ruling.

You might imagine that 1/12th of ownership costs may be private and non-deductible. Hmmm not so. I encountered a ATO audit where they calculated that the holiday rent for the private period was say $3k a week ie $12K in rent was foregone. And the property produced $4k all other times of the year. So the ATO limited deductions to the $4k of income and argued there wasnt a intention to produce income, just to defray private costs. A key factor was they also used the property for a weekend here or there "when it was vacant" adn turned out to be 10+ weekends a year + parents and others staying there (the managing agent who handled linen disclosed that to the ATO). The taxpayer had been told by their accountant to claim all but 1/12th of costs. ATO also cancelled Div 40 and applied the new rule.

 

Yep. Definitely not occasional. They disagreed.

 

ATO applied a high degree of culpability to penalties. Not just reckless but intentional. Tried to argue they relied on advice but ATO didnt agree and didnt accept the safe harbour applied. They argued false & misleading statements by owners and accountant (based on agent disclosure and accountants ADMISSION re the 1/12th) , no reasonable position etc....Applied this view to 2 years. The big costs in the disallowed claim related to land tax, maintenance and interest since they held a high LVR IO loan on the holiday home etc.

 

In our schedules we include the plant and equipment’s depreciation in an appendix that we call as capital loss statement. For all intents and purposes, it looks like a depreciation schedule but you can’t use it to claim depreciation.

We’re aware that different people might have different perspectives on how these figures are applied in the event of a capital gain. Our role is to provide the figures but further guidance is only ever in line with what’s set out by our governing body, the Australian Institute of Quantity Surveyors.

The AIQS guidelines published back in November 2017 are (pasted verbatim; see attachment):


"Some Tax Depreciation preparers have told me that they are going to provide full tax depreciation schedules for every client, even if they can’t claim any depreciation, as they will assist their clients in claiming capital losses. What do they mean by this…

Where the depreciation deductions are denied, if the depreciable asset is sold or scrapped for a loss, this will create a capital loss. But remember that a capital loss can only be applied against capital gains so many owners of rental properties will just decide to treat the entire purchase price as the price for the land and buildings as capital gains will only arise when they sell the property. For example:

Tom buys a rental property and under the new rules he cannot claim any Division 40 deductions.

He is told to get a tax depreciation schedule to work out what will be the capital loss on the depreciable assets when he sells the rental property and the report comes back and says of the $500,000 he spent on buying the rental property, $20,000 related to depreciable assets.

Tom therefore treats the cost of the building as $480,000, and from the depreciation schedule says he spent $20,000 on depreciable assets.

Tom sells the rental property for $600,000 two years later and states he sold the land and building for $600,000 and the depreciable assets for $0. Tom therefore makes a $20,000 capital loss on the depreciable assets. But he also makes a $120,000 ($600,000 less $480,000) capital gain on the land and building. The net effect is a capital gain of $100,000.

Tom then realises that if he had not have paid for the depreciation schedule he would have treated the $500,000 he paid when he bought the land and buildings and when he sold the land and buildings for $600,000 he would make a $100,000 capital gain.

Exactly the same outcome. Tom now wants a refund of the fee he paid for the schedule.

The only possible potential benefit in getting a schedule is if you scrap the depreciable assets years before you sell the property as the capital loss arises in the year you scrap. But as capital losses can only be offset against capital gains you only get to use the capital losses when you sell something else that has a capital gain... and in many cases this will be the sale of the rental property in a few years time. Once again, no benefit in getting the schedule. And even if there is a benefit, it is merely using the capital loss in an earlier year, so not much of a benefit"


That position is backed up by the National Tax and Accountants’ Association (NTAA). Obviously the rulings are still young and we're waiting on further word from the ATO on some aspects of the legislation. E.g., Advice under development - capital gains tax issues

 

I find the use of a QS report to scrap individual assets very concerning for the potential for error and time consuming waste of time. Its far too easy for a specific asset to be scrapped but then the continuing write off is maintained so a double dip could occur. The schedule isnt easily "corrected" for the scrapped item (it is PDF) and its hardly viable for a QS to amend to remove just the split system for example. This same issue has always been the case for disposed / scrapped or replaced assets. As a tax agent I dont scrap items in the report for fear of this double dip creating a concern. If there are sufficient items for a revised report then that is likely to be worthwhile.....It comes down to each QS firm. I doubt there is a viable position for them to write off dishwasher this year and blinds next year etc.

I would argue its far easier for taxpayers to use the reports and the deferred depreciation summary page (or whatever the QS calls it) so that a single adjustment is made at the time of property sale OR if the property is demolished etc at a later date.

I think as I read the BMT comment it also highlights that there seems little benefit claiming a loss here or there. Just claim a single adjustment when the property is disposed. Not $200 this year, $150 next year and so on and finally $14,000 in ten years when sold.

 

Hi Terry, suggest a few amendments to the calcs in your example above.
If purchased for $500k with $100k of P&E included, that leaves house price of $400k + the P&E $100k to total $500k.
So when sold combined value for $700k including remaining $70k of P&E, I believe the calcs should be
House (ex P&E component) $630k - $400k cost = $230k gain.

P&E sold for $70k -$100k cost = (30k) loss

$230k gain - $30k loss = $200k gain before 50% disc etc.

As Paul & BMT mention above, this is the same result as $700k - $500k = $200k capital gain.

 

I am not good at maths

 

The swami guru has a fault! Awesome at tax & legal but not maths

 

thank you for your honesty post, i was thinking about renting my place and asked quote for depreciation schedule until I realised that i could not claim the plant and equipment due to the 2017 new rule.
I built the house and I have the cost of the capital work (brick work, roof etc.. but not the plant & equipment) so I told the depreciation provider that I don't need the schedule anymore because I can't claim on div40, and since i have the cost of the building I can work out the depreciation cost of 2.5% myself.
The provider replied that i can still claim on the div40 to reduce my CGT if I sell and to claim depreciation, the report must be done by a quantity surveyor - however I read the article you posted and it says that if I know the cost then I need to use my cost - so i assume it is ok for me to use the builder's invoice to claim on div42 and I dont plan to depreciate on div40. am I correct? as long as I keep the invoices, i can show to the ATO if they audit me?

I was also maybe considering not depreciation div42 becuase my house value lost $100k (in Perth) and if I sell, it will reduce my cost base and will reduce my loss...however I probably won't have anything to offset the loss with, except maybe some CGT from selling shares but that will probably be a small amount. what are you thought about that?

thank you again for your honesty.

 

Assuming you're referring to Division 43 (the capital works/building allowance), in theory there's nothing wrong with what you're saying. The only thing I'd note is that it is rare that investors have the cost breakdown to such an extent that they can clearly separate every Division 43 and 40 element (which is why a quantity surveyor is required to make estimations). If you have a cost for every Division 43 element clearly defined, then, yes, it becomes a simple matter of dividing by 40 to get the 2.5% allowance.

Are you sure you have every Division 43 cost (or are able to separate every Division 40 cost from the total construction cost)?

This strays into the realm of me being asked for financial advice, which I can't do. In most cases, however, depreciation will create additional cash flow through tax savings while you're holding the property, which could still be preferable. That's about the limit of what I can say here. How long are you renting it for? Do you have concrete plans to sell it or are you talking hypothetically?

 

The Builders invoice is a poor source for depreciation. As a tax adviser I would avoid using it and refer all clients to a QS. A builders invoice to me is 100% DIv 43 at 2.5% where QS wil identify other elements - Like fencing, appliances and plant items and fixtures and fittings such as carpets etc. Other elements of the building could include alarms, ACon, fans, hWS, door closers, fixed heaters, automation assets, lights, skylihts, ... and I only just started. IMO it would be negligence on may part to use a builders invoice for a full dwelling construction.

I believe that a claim for Div 43 and 40 should always be made if available. The deductions would enhance cashflow beyond CGT issues which at 12mths + have a 50% value anyway. And if sold at a loss there would be no CGT and just missed deductions.

If the deductions for a dwelling in year one are $12,000 this likley refects a cashflow benefit of $4200 + vs a report cost of say $770. Pretty good ROI in my view. If the builders invoice was used the deduction may be say $7K. A refund of $2450. Repeat this annually.....

If a sale is proposed so soon after completion broader tax advice concerning the proposed sale should be considered as it could be signs of a enterprise and trigger a GST issue.

 

thank you for your message, my invoice was breakdown into 6 components (Commencement, Slab, Brick, Roof, Plaster & Practical Completion) , I would have assumed that i could claimed div43 for everything except the "Practical Completion).

I don't have plan to sell the house at this stage.

thank you, will have a look at a QS