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:
To help explain the implications of property depreciation on CGT, here are six facts investors should be aware of:
1. What is property depreciation?
2. How do capital works deductions affect CGT?
3. How does plant and equipment depreciation affect CGT?
4. What CGT exemptions apply for a principal place of residence?
5. Are property investor’s eligible for a discount?
6. Is it still worthwhile claiming property depreciation if it will later add to the capital gain?
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.
Learn more: Invest smarter with a tax depreciation schedule
4. What CGT exemptions apply for a principal place of residence?
Properties which are owned by someone who resides, occupies or lives in the property as their home are exempt from CGT so long as the dwelling is used mainly for residential accommodation and is located on land under two hectares in size.
If the owner of a primary place of residence chooses to move out of their home and rent it out, a CGT exemption is available for up to six years after they have moved out so long as they don’t own another primary place of residence.
If the owner moves back into their investment property, then moves out and rents the property again, a new six year period will commence from the time they last moved out of the property. There is currently no limit to the number of times a property owner can do this so long as each absence is less than six years.
Only one property can be classed as a primary place of residence and therefore exempt from CGT at any one time with the exception of the following rules which apply if both properties are treated as the owner’s primary place of residence within a six month period:
- The old property was the owner’s primary place of residence for a continuous period of at least three months in the twelve months before they sold it
- An owner did not use the property to provide an assessable income in any part of the twelve months when it was not their primary place of residence
- The new property becomes the property owner’s primary place of residence
5. Are property investor’s eligible for a discount?
A 50 per cent exemption on CGT is available to individuals or small business owners who hold an investment property for more than twelve months from the signing date of the contract before selling the property.
6. Is it still worthwhile claiming property depreciation if it will later add to the capital gain?
The short answer is yes. During the term of ownership, capital works and plant and equipment can be claimed as a deduction at the investor’s marginal tax rate. These deductions will reduce tax liabilities, therefore generating additional cash flow for the investor each year.
When a property is sold, if the owner has held the property in their name for more than twelve months, the owner will be eligible for the 50 per cent exemption. This means that only 50 per cent of the capital works deductions during ownership will carry through to the ‘CGT event’, making it far better for a property investor to claim the capital works deductions and take advantage of the additional cash flow during ownership. Depreciation claims also provide an opportunity for the property owner to invest further or reduce loan liabilities.
When considering selling an investment property, it is recommended that investor’s seek advice from their Accountant about the implications of CGT and the exemptions available. A specialist Quantity Surveyor can also provide advice on the depreciation deductions for any investment property.
For more information on property depreciation, visit our BMT Tax Depreciation frequently asked questions webpage or alternatively, speak with one of our expert staff on
1300 728 726.
Hi there, I bought a unit 6 years ago, which I lived in for one year. Then I moved overseas and have rented it out for the last five years. I thought I had six years before CGT applies, but am I now a “foreign investor “? (I’m an Aussie citizen living overseas) And therefore CGT applies in full? How can I minimise this, including moving back in for a while?
Hi Fiona,
Thank you for your enquiry. I will have one of our expert staff contact you.
BMT Team
I had an investment 2014 and sold 2018
all depreciation costs for 4 years that I claimed as a tax deductions for about 7000 in total
do I need to add back to cost base price? of the property for CGT and because its more than 12 months I am entitled for 50% CGT?
Hi Becky,
Thank you for your enquiry. I will have one of our expert staff contact you.
BMT Team
Hi
We have owned a rental property since 2001 and lived in it while we built another home in 2008 for 2 years. The property value has increased quite substantially and was wandering how capital gains would affect us after retirement.
Hi Dianne,
Thanks for your question. Based on this information you have provided, you will most likely have to pay the capital gains tax (CGT) when it comes time to sell one day, whether this is during your retirement or otherwise, given that it doesn’t sound like this property is your primary place of residence. The good news is that under current legislation you would be eligible for a 50 per cent exemption on CGT, given that you have held the property for longer than twelve months. Feel free to drop us an email at socialmedia@bmtqs.com.au or call us on 1300 728 736 if you’d like to chat more about this at all. Alternatively, we recommend that you get in touch with your Accountant as they will be able to provide advice relating to your specific circumstances.
Thanks,
BMT Team
I would like some clarification on depreciating your PPoR. I bought a house built in 1960 which I moved into straight away (June 2015). In the 15 months I was living there I had renovated the house (new kitchen, new laundry with second shower ect). The property was leased in September 2016 due to a change in my circumstances. My question is, will depreciating the improvements (made while I was living at the house) during the time the property is income producing trigger a CGT event EVEN if I move back into the house within 6 years?
Hi Chris,
Thank you for your query. In this instance we would recommend contacting your Accountant as they will be able to provide advice relating to your specific scenario and whether any deductions you claim to your primary place of residence would affect Capital Gains Tax when you decide to sell the property.
Thanks
BMT Team
I have lived in my property for 18 years and am about to rent it out. The value of the house has increased since the original purchase price (a lot). Will I pay CGT from the purchase price to when I sell it or on the value today until I sell it?
Regards
Belinda
If you get a market valuation at the time you rent out the property, the capital gain is calculated by the difference between the final sale price and the property value when it was rented. If you don’t get a market valuation, they will use the purchase price for the value.