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One question investors often ask about claiming depreciation on a rental property is ‘how will these claims affect Capital Gains Tax (CGT) when the property is sold?’
CGT can be a complex topic for investors to understand, particularly as the answer to the above question can really depend on the scenario of the individual property investor.
Introduced on the 20th of September 1985, CGT is basically the tax payable on the difference between what it cost you to purchase an asset and the amount you received when you disposed of it. When you sell a property, this triggers what is called a ‘CGT event’ and the owner will either make a capital gain or loss on the property. To calculate your capital gain or loss, use the following method:
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To help explain the implications of property depreciation on CGT, here are six facts investors should be aware of:
1. What is property depreciation?
Property depreciation is the wear and tear of a building and the plant and equipment items within it*. The Australian Taxation Office (ATO) allows owners of income producing properties to claim this depreciation as a deduction in their annual tax return, meaning they pay less tax. Property depreciation is made up of two main parts: capital works deductions and plant and equipment depreciation.
2.How do capital works deductions affect CGT?
Capital works deductions are available for the wear and tear on the structure of the building. Examples of items which can be claimed include bricks, walls, floors, roofs, windows, tiles and electrical cabling. The capital works deductions will reduce the cost base of the property, which will add to the capital gain and therefore increase the amount of CGT applicable for the owner of the property.
3.How does plant and equipment depreciation affect CGT?
Depreciation deductions can be claimed for the mechanical and easily removable plant and equipment assets contained within an investment property*. When a property is sold, a gain or loss is calculated separately on these items. As outlined by the ATO on their website, you can make a capital gain if the termination value of your depreciating asset is greater than its cost. You make a capital loss if the reverse is the case. That is, the asset's cost is more than the termination value.
* Under new legislation outlined in the Treasury Laws Amendment (Housing Tax Integrity) Bill 2017 passed by Parliament on 15th November 2017, investors who exchange contracts on a second-hand residential property after 7:30pm on 9th May 2017 will no longer be able to claim depreciation on previously used plant and equipment assets. Investors can claim deductions on plant and equipment assets they purchase and directly incur the expense for. Investors who purchased prior to this date and those who purchase a brand new property will still be able to claim depreciation as they were previously.
To learn more visit www.bmtqs.com.au/budget-2017 or read BMT’s comprehensive White Paper document at www.bmtqs.com.au/2017-budget-whitepaper
4.Have the recent changes to depreciation legislation had any effect on CGT?
The amended legislation following the 9 May 2017 Budget outlines some detail around a reduced CGT liability for property investors. There are scenarios where the values of plant and equipment will be needed. This includes when an asset is scrapped, where there is a partial or full CGT exemption and where the exchange date and settlement date on the sale of the property occur in separate financial years. The BMT Capital Allowance and Tax Depreciation Schedule includes the capital loss values on plant and equipment to allow the offset against any future capital gains, should a property investor dispose of the assets. We recommend that investors speak with an Accountant or Tax Adviser when completing this process.
Depending on the circumstances, a property investor who is unable to claim depreciation on previously used plant and equipment assets due to these amendments should be able to claim a capital loss for the decline in value of the plant and equipment assets. This capital loss should only be able to offset a capital gain and if needed can be carried forward to offset future capital gains.
5. What CGT exemptions apply for a principal place of residence?