There is no doubting that natural disasters have rocked Australia in 2020. It’s key that property investors know how they can deal with the destruction of their rental property from a taxation and depreciation point-of-view.
How and if this can be done largely depends on the insurance proceeds received following the disaster.
Depreciation with no insurance claim
When there’s no insurance proceeds the property owner can claim depreciation deductions on the new structure and plant and equipment assets once the property has been re-constructed. The owner can also immediately write-off any qualifying un-deducted values on the destroyed assets in the same financial year.
Capital works deductions when insurance claim is made
Insurance proceeds relating to the structural element of the property will reduce the claim available on any un-deducted division 43 left on the original destroyed structure. Future division 43 deductions will then need to be established. This is done by considering the possible capital gain and any additional insurance proceeds remaining after these adjustments.
Another key consideration is how the insurance proceeds were received, for example as cash or as asset replacements. These must be considered in conjunction with other factors under subsection 124B of the Income Tax Assessment Act 1997 (ITAA 97).
Plant and equipment depreciation when insurance claim is made
The plant and equipment assets destroyed will be subject to a balancing adjustment event. This is where insurance proceeds will be either assessable income if proceeds exceed the un-deducted written-down value, or, deductible if the proceeds don’t exceed the value.
It’s common for insurance proceeds to fall into the ‘assessable income’ category as the new plant and equipment asset will usually have a value higher than the older asset’s un-deducted amount.
Rollover relief for plant and equipment assets
The Income Tax Assessment Act 97 (ITAA 97) covers the involuntary disposal of assets under rollover relief.
Depending on the individual scenario, rollover relief may be available. This is introduced when insurance proceeds are higher than the un-deducted values and allows the owner to offset the cost of replaced assets. This effectively reduces the assets ongoing depreciable value, rather than being assessed on the excess from the balancing adjustment and becoming assessable income.
When eligible for rollover relief, the owner may end up with a new asset that has a similar opening value as the written-down value of the destroyed asset.
Insurance proceeds and repairs
Depending on the situation, a portion of the insurance proceeds may relate to deductible repairs to the investment property.
For example, if only part of an external cladded wall suffered smoke damage and the owner only had to fix this part of the wall and the rest remained, proceeds would then be classed as assessable income can be claimed as a deductible expense.