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,
I have a query and just require a little clarification on the following.
I bought a house in Nov 2013 and moved in immediately with my wife it was our main residence. We moved out in May 2014 and rented it out due to our marriage breakdown, we are now divorced. We both moved into separate rental accommodations, neither of us owned another property.
We sold the property in January 2016.
Can I seek an exemption of CGT under the 6 year law?
Hi Lee,
Thank you for your question. As you don’t own another residence or primary place of residence, you should be able to seek an exemption from CGT under the six year rule. We recommend discussing your individual circumstances further with your Accountant.
A house built purely for investment say 6 or 7 years ago, has never been lived in as owner occupier. If you later choose to relocate and live in that same house as an owner occupier, and have no other owner occupied residence at that time. Is there a period of time you need to live in it to negate any CGT for all that time it was a rental?
Hi Greg,
Thank you for your comments and your question.
We would highly recommend speaking with your Accountant if you are consider moving into a property that has previously been used as a rental.
There will be CGT that will apply for the period that the property was rented. However, CGT won’t apply from the point you move in as the property will no longer be income producing.
From our understanding, a property needs to have been lived in prior to having been rented in order for full CGT exemptions to apply, but your Accountant should be able to provide advice based on your individual circumstances and work out what portion of CGT will apply for the period of time your property was rented.
In 2 and 3 of your article Capital Works depreciation that has been deducted is charged back and increases the CGT . But plant and equipment depreciation claimed isn’t charged back or taken into consideration. Your information is confusing. Could you explain more clearly please.
Hi Brian,
Thank you for your comments. CGT is calculated separately on plant and equipment assets. For further details on this from the ATO, please see the following link:
https://www.ato.gov.au/General/Capital-gains-tax/In-detail/Business-assets/CGT-and-depreciating-assets/
Hello
I currently have an investment property that was my PPoR and is coming up to the six year period of being rented
What is the minimum period that you can move back in before you can reset the 6 year period?
Also, does CGT apply uniformly across Australia or is each state different?
Regards
Michael
From our understanding, there is no minimum time frame so long as you can provide proof that you moved back into the property. However, we would recommend you speak with your Accountant to discuss how the CGT exemptions will apply based on your individual circumstances.
I sale a property with a garage, I use the garage for three years and rent the unit until now.
If I decide to sell, can I use the six years rule on the garage only?
The garage and the unit have different entitlements unit points to allocate price
on selling.
Regards
Damian
Hi Damian,
Thank you for your query. If they’re being sold together, it can be difficult to separate a garage to apply a CGT exemption.
However, if your garage has its own lot and is being sold separately, you may have a case to claim a CGT exemption.
As you situation is quite unique, we recommend discussing your circumstances with your Accountant.