Tax treatment of insurance payout for flood damage to a rental property.

One for the accountants.
I have a question about the tax treatment of post flood expenditure on a rental property.
The scenario is:
Pre 87 built house in original condition. Trashed in a flood.
- Client received a payout of 70K from their insurer.
- Insurer also spent an estimated $80K on other repairs.
- Client then elected to spend an additional $100K improving the property.
The accountant wants a Dep Schedule that covers the whole $250K expenditure but I'm not sure that is correct.
- I would have thought the insurance payout would be treated as income and offset 100% by a repair claim.
- Work done by the insurance company cannot be depreciated by the property owner.
- Improvements made by the client can be depreciated.
I never like to query an accountant because they sometimes get a bit defensive.
Scott

 

This relates to THE BUILDING right ??

The building hasnt been replaced in its entirely so its highly likely to be a 100% deductible repair. but read on..... eg new wall linings, new flooring, kitchen and other fixtures etc...And its important that the property hasnt been entirely destroyed. This ruling address a fire and the tax treatment for destruction of the asset. Legal Database

1. The portion of the former assets (if any) could be scrapped although the age of the structure could be a problem.
2. Insurance proceeds assessable where they exceed the asset cost etc
3. Costs to repair all deductible.

The proceeds from the insurer for the repair element may actually be a CGT receipt and not assessable. See the difference between Q2 and Q3 in the link above. I believe in this example the insurer paid $$ to the owner who then made the repairs. The tax adviser needs to consider a costbase adjustment which will reduce the value for later CGT.

But if the insurer does the work its not a repair cost incurred by the owner so nothing can be claimed and there is no substantiation. And despite what insurers say about like for like for tax purposes the newer bit is not alike to the former 1985 asset. It has a new effective life ? Its a capital cost to reinstate the asset destroyed. Scrapping may be available for what was lost BUT not if its old and pre-Div 43?? The owner cant claim that reinstatement or repair cost BUT....I see no limit to claiming Div 40 + 43 based on the assessed cost for all the new works provided a clerk of works or QS assesses the cost in the absence of actual cost records. See Q6.

The issue with renovating along with repairs makes it somewhat difficult to determine which is which doesnt it ?? But it could well all be subject to a QS report - Not necessarily $250K however.

Its likely a QS schedule will address much of the cost.

 

You need to clarify if the $70,000 is just to repair insurance damage, or is for loss of income, or anything else as this will affect how it's treated.

Rental properties and business premises

The $80K by insurer will be repair costs (offset by 'income') - net effect is $Nil.

I would think the insurer is only restoring what may have been eligible for capital works deduction, so any existing deduction should just continue, subject to what may have been destroyed/replaced by the $100K spent.

For P&E = if you (as a QS) didn't know anything about the need for insurance work, I assume you would see (for example) "new stove" and estimate a date and value for depreciation?

I'm sure Paul will have a comprehensive answer to this

 

$70K payment to the client by the insurer was specifically to repair the property.
$80K is an estimate on what the insure spent themselves repairing the property.
So the insurer spent $150K in total - $70 of that being a payment to the client for them to manage.
The client then elected to spend an additional $100K of his own money making changes/improvements to the property.
There was no existing Cap Works deduction in play because the property was built pre 87 and in original condition.

 

Hmmm... No schedule prior. OK.

The $70K paid to the client may merely reduce the CGT costbase if the CGT costbase is more than $70K. Its a decreasing adjustment to the costbase according to Taxation Ruling TR 95/35. If the taxpayer spent the $70K then the nature of the expense as either a repair (deductible) or capital works or Div 40 is required based on actual costs. If they spent more then thats the cost. If less thats the cost.

The $80K seems like eligible Div 43 / 40 based on a QS determined cost. Absence of actual cost records requires this. Taxpayer owns the asset.

The extra $100K would be Div 40 / 43 based on actual costs.

I dont accept that $250K can be used for Div 43. Certainly some is a repair cost to the building. A QS report may maximise the available depreciation rates and methods for specific content beyond that. And if the assessed value of the insurer initiated works may be higher or lower than the understood claim value. Insurers can sometime fix things through bulk pricing v's what other may pay. eg Did the insurer mention GST exclusive or included ?? I bet they use ex-GST costs. In reality a homeowner will pay GST inclusive which is 10% more.

I would argue that the owner needs to work with the tax adviser to identify the cost that has been incurred by them for repairs. Then do a QS report. Div 43 and 40 - The parts paid by the owner and parts done by insurer are probably all hopelessly blended and so one report covers it all ??

 

Thanks Paul.
That mostly makes sense.
I'm glad I was on track in questioning the validity of dumping the whole $250K into a Dep Schedule.

 

Yeah that wont be diligent or max benefits. Poor approach by the tax adviser IMO.