What happens when depreciation exceeds purchase price?

Discussion in 'Accounting & Tax' started by smallbuyer, 23rd Jan, 2017.

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  1. smallbuyer

    smallbuyer Well-Known Member

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    What is the situation with depreciation in mining towns with huge price drops?

    For example if I buy a 3 year old property in Moranbah for $100k but the build cost was $350k. Could I claim depreciation on the whole $350k build cost, getting say 15-20k of depreciation in the 1st few years? What happens when the deprecation claimed exceeds the purchase price in 5-10 years? Can you keep claim depreciation or do you have to stop claiming? Any thoughts?

    Cheers,

    Smallbuyer
     
  2. D.T.

    D.T. Specialist Property Manager Business Member

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    Purchase price is not really relevant i don't think. A quantity surveyor will merely value the assets and fixtures and you get x% of that accordingly.

    @Depreciator can perhaps clarify?
     
  3. Scott No Mates

    Scott No Mates Well-Known Member

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    Remember that you have to add back the depreciation when you sell at a loss, you may still have to pay cgt.
     
  4. Barny

    Barny Well-Known Member

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    How's this work exactly? Always wondered in case I sell a lemon.
     
  5. bumskins

    bumskins Well-Known Member

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    Depreciation changes the cost base when you sell.

    So if you buy something for $300,000 and in year 1 claim $10,000 depreciation (tax benefits). Then you are saying its now worth $290,000.

    So if you sell it at the end of year 1 for $300,000, as the building has depreciated by $10,000, then the land must have appreciated by $10,000 for the value to stay the same. For which you need to pay Capital Gains tax on.

    The major benefit from depreciation is it can massively improve cashflow while holding and then if you sell at a profit it interacts nicely with the 12 month 50% discount holding rule.
     
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  6. Ross Forrester

    Ross Forrester Well-Known Member

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    TR 97/25


    41. Damian is a property developer who constructs a condominium of 38 units in a popular holiday resort. All units are intended for sale. During the construction period, he sells 28 of the units off the plan. After completion of the project, real estate prices drop significantly and he decides to sell the last of the units below cost.

    David, an investor, buys one of the last units for $95,000. The actual construction cost of the unit to Damian was $105,000. David is entitled to a deduction under Division 43 based on construction expenditure of $105,000.
     
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  7. BMT Tax Depreciation

    BMT Tax Depreciation Chris Business Member

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    If by depreciation you're talking about both the capital works allowance and plant & equipment depreciation, this would be a low claim for "the 1st few years" on a building of that age. Heck, it would be skimpy for two full financial years.

    No effect. Keep claiming. Depreciation is not related to value in this way.

    Don't forget that it's only the capital works allowance that factors directly into the cost base (and hence $10k in one year for capital works allowance alone means you're looking at a pretty swish build). For your plant & equipment depreciation, the situation is a bit more complicated and you should talk to your accountant (though I know @Paul@PFI has detailed his opinions on the topic previously).

    This is the crux of it. In my time at BMT I've only heard a couple of accountants advise their clients against cash flow for the sake of saving an unknown quantity of tax in the future.
     
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  8. BMT Tax Depreciation

    BMT Tax Depreciation Chris Business Member

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    This is contingent on David having the construction cost available. This doesn't happen a lot, though the ATO mandates that we ask for the information from the owner.
     
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  9. Mike A

    Mike A Well-Known Member

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    plant and equipment does affect the cost base.

    the reason. purchase price and sales proceeds needs to be allocated between the plant and equipment and "other" e.g. land and building.

    so if you purchased a property for 500k and 60k of that purchase price represented plant and equipment as per the depreciation schedule then your cost base on purchase would be 440k.

    the sales proceeds are likewise allocated accordingly. if that plant and equipment had been depreciated to zero and zero was the fair market value of the plant and equipment than the sales proceeds would not be reduced by anything.
     
  10. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Great OP question I think. The response could get too technical so I will simplify the issues. There are two "hidden" QS issues surrounding price drops in regional towns affected by major price falls for property that is tenanted at any time.

    1. The QS issue issue identified by the OP.
    The reduced cost base of a property used to calculate CGT would normally be based upon the historical cost and then reduced by the value of all QS deductions claimed regardless of whether its Div 40/43. I refer to Ross's succinct post above. The QS report is based on ORIGINAL construction expenditure or the QS estimate of what that was if actual costs are not know and a QS report is used. Yes it may be higher than the market value paid but as land is included in "cost" its improbable to be as I exaggerate below. But its possible. However technically a deduction cannot be claimed beyond the cost of an asset. (It will ignore all the complexities)

    A cost base cannot be reduced beyond zero. Deductions claimed beyond the cost base trigger a non-discounted capital gain in the year when such a deduction is claimed.This is akin to a taxpayer who owns shares who may receive a return of capital on shares. The ROC is not taxable until such time that the costbase becomes zero. All return of capital after that point are assessed as income through the CGT provisions in the year received.

    So what may occur is that the remaining $150K of cost (see below example) will erode faster.

    2. Taxpayers who use s118-192 (the special rule for first production of income) may also be adversely affected by the example given.
    • Buy an property in regional QLD lets say cost $400K
    • Work and reside in property for a period of time
    • Retrenched and no prospect of work in twon. Need to relocate. Property value has fallen and sale is NOT an option. So rent it out ?
    • QS assesses the available QS deductions at $150,000
    • s118-192 applies and lets say market value of property is $100,000 to be silly
    • So the property cost base for CGT is now $100K exposing taxpayer to pay CGT on the whole of the price recovery if the market recovers. Unfair ?? Sure is. But that is the law.
    • There are two issues here:
    1. Can a taxpayer appeal this ? No. Rapid erosion of the costbase by the "inflated" QS deductions are going to defer a tax issue that amplifies CGT if and when sold. This amplification is due to the very high deductions v's the low costbase created by s118-192 and the QS value; and
    2. The special rule in s118-192 has additionally unfairly affected the taxpayer so that $300K of potential CGT profit may occur if the property market recovers. IMO this is unfair and s118-192 should be rewritten to exclude operation of a s118-192 loss when a property first produces income unless the taxpayer elects to do so.
     
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  11. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    P&E deductions are a small portion of a QS report in most cases (esp regional areas!!) and often accelerated claims see it written down in little time. The P&E issues are trivial IMO. The bigger issues are the Div43 which becomes more enduring....I think the OP has used a general term and the focus on P&E masks the true question and concern. See my other example in preceeding post.
     
  12. BMT Tax Depreciation

    BMT Tax Depreciation Chris Business Member

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    Fair enough. But while P&E will account for only about 15% (on average) of total deductions for a brand new property, if you're looking at individual years (such as the opening years, which is what I meant in my response), P&E deductions can easily be, say, a good 40% of the first full financial year's claim.

    When talking about older properties, P&E can even constitute the majority of deductions available, depending on the level of renovation.

    But, yes, we're moving away from the intent of the original question. Regarding the rest of your comments, we will always defer to accountant advice on issues like these, though we can't assume a level of proficiency.
     
  13. Barny

    Barny Well-Known Member

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    IMG_6681.PNG IMG_6680.PNG IMG_6678.PNG I know this differs from the op's question but was hoping someone could help explain, instead of starting another thread.

    Trying to work out what the total loss is if you sell a lemon for less than purchase price, and including the depreciation as I'm not understanding it.
    Some figures....
    Purchase price 217k as a rental from day 1.
    Say 13k in stamp duty and legal. So total 230k
    Haven't included insurance/land tax etc for cost base for now just to keep it simple.

    Say in ten years it's sold for 180k
    Total depreciation is in pics provided from bmt, not sure which figures to include as total deprecation over the 10 years.

    So what figure would the cost base be?

    Appreciated
     
  14. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Agree...And especially newer properties where air con, water heaters, solar, etc and the like are newer. And agree some older properties may have zero Div 43 and with a reno kitchen and air, water heater etc perhaps 100% of the deduction are shorter term but still highly viable Div 40.

    Each property has its unique fingerprints. Chris, you will like my view here - I suggest the QS advise on the merits of a schedule.

    Chicken or the egg. Which came first ?
     
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  15. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    I dont reply based on real reports but lets assume its $5K deductions a year average.

    Costbase is $230K plus add in legals, any costs of improvements or non-deductible issues etc. Add in selling costs too. Then reduce costbase for the $5kpa x 10 years = $180K

    So zero profit.
     
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  16. Barny

    Barny Well-Known Member

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    Thanks paul. 180k cost base if I don't add legals or improvements in this example.
    So does this mean for this example its treated as a 50k for cgt?
    Or zero tax
     
    Last edited: 24th Jan, 2017
  17. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Read the final line of my post.
    No profit means...How much tax ?
     
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  18. Barny

    Barny Well-Known Member

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    No tax, thanks Paul