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Scrapping is the removal and disposal of any potentially depreciable assets from an investment property. In other words, demolition of any existing structure or fixture onsite that would have been eligible to claim deductions for depreciation (Division 40) or building write off allowance (Division 43).
How does an investor benefit by scrapping?
Scrapping of existing structures onsite is a very effective method of obtaining deductions within our tax system. It can provide additional tax credits for investors who demolish or dispose of existing buildings or any part of it which were owned as an investment asset and eligible to produce income.
Essentially, if an item is scrapped the amount that is yet to be written off for a particular asset (the residual value) can generally be claimed as a 100% tax deduction at the time of disposal.
Examples of these potential benefits
Example 1:
David purchased an existing house a year ago. The property was approximately 50 years old and was acquired as an investment. The property has been producing income since the purchase. There was no capital allowance deduction available on the building structure due to the age of the property (pre 1985 construction). However, all plant and equipment items in the property were depreciable. This typically includes items like the carpets, blinds, air conditioners and hot water systems.
After BMT & ASSOC conducted a detailed site inspection and noted the eligible plant and equipment, a depreciation report was prepared. This resulted in identifying $15,000 worth of deductions. Whilst the property was income producing, David claimed a total of $2,700 in deductions in his first financial year. David decided it was time to build a new investment property on the site. In doing so the existing building was demolished and removed from site and therefore he was happy to find that the residual value of $12,300 became an immediate 100% deduction in the year of demolition.
Example 2:
Mark operates a panel beating workshop. In 1993, he constructed a new service bay. In 2004, due to increased technology and demand, the existing service bay became redundant. Mark decides to build a larger service bay that can accommodate his needs. After completing the additional bay, he demolishes the 1993 extension and replaces it with office space. In his tax return for the income year of 04-05, Mark can deduct an amount in respect of undeducted construction expenditure related to the 1993 extension.
Clarifying Potential CGT Implications
Many property investors falsely believe that claiming the remaining tax depreciation benefits on a property that is being demolished is not worthwhile. In fact, property investors are generally able to claim the balance of depreciation on any income producing property that is being demolished – for both the eligible Division 43 capital works allowance (building) and the Division 40 plant & equipment items. This assumes nothing is gained from the items that are scrapped.
The following points are provided to clarify the finer details of the process:
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Any financial gain recorded against the disposal of the depreciating asset will add to the assessable income;
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CGT is only applicable to the qualifying Division 43 capital works, not the Division 40 plant and equipment assets;
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Investors have the ability to scrap all Division 40 items and Division 43 works which qualify for a deduction at the time of demolition;
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These deductions will reduce the taxable income (company or individual) by the exact amount of the claim;
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For CGT purposes the deductions for Division 43 may reduce the original cost base;
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If owned by an individual, then generally half the CGT amount will be added to their taxable income and taxed at their marginal rate; and
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If owned by a company, then the full CGT amount will be assessed as income and taxed at the company tax rate.
With every potential investment scenario the deductions that may be obtained vary dramatically. In most cases scrapping will present a benefit.
It is a complex procedure to prepare a report which will give you all the information you need to make the claim. The process involved in determining the amount of potential deductions available from a property requires the engagement of a specialist quantity surveyor.
If you require any further information or clarification on scrapping as it applies to your individual situation, you should contact your accountant.
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