Depreciation and disaster
What can you claim in the event of fire damage?
This year Australia has suffered through some of the most destructive bushfires on record with a devastating impact on many Australian lives. Since the start of the 2019-20 fire season, a staggering 10 million hectares of land has burned across the country.
As countless pictures and stories of the horror of the bushfire season emerge, people across the country and around the world are contributing to the ongoing relief effort. Many homes, schools, investment properties and businesses have been destroyed, all of which will need to be rebuilt or repaired in the coming months and years.
BMT Tax Depreciation has experienced a substantial increase in requests for information about how an owner can deal with the loss of a rental property from a depreciation and taxation perspective. We’ve put some of the basics together to offer guidance and hopefully provide much needed relief in the form of tax deductions for destroyed items and the replacement assets.
Depreciation is a deduction available to owners of income-producing properties for the wear and tear that occurs to a building and the plant and equipment assets within it. This deduction is available on both the structure of a building and its fixed assets like windows, doors, roof, footings, walls and tiles, along with any qualifying removable or mechanical plant and equipment assets like hot water systems, stoves and carpets. When part or all of a property is destroyed, the outcome from a taxation perspective can become complex.
In most scenarios an insurance payout will be issued. Usually, when considering the tax implication of the insurance proceeds, the structural element (claimed under division 43) and the plant and equipment assets (claimed under division 40) are treated separately.
Capital works deductions
Insurance proceeds relating to the construction costs will reduce any leftover or un-deducted division 43 available on the original structure. Future division 43 capital works deductions will then need to be established considering a potential capital gain and any additional insurance proceeds remaining after these adjustments. Consideration will also need to be given to how proceeds were received, whether in cash or asset replacement, along with a few other minor factors under subsection 124B of the Income Tax Assessment Act 1997 (ITAA 97).
Plant and equipment deductions
Similarly, with the individual plant and equipment assets there will be a balancing adjustment event whereby insurance proceeds will end up being either:
- assessable income, if the insurance proceeds are more than the un-deducted written-down value of the plant item
- deductible, if the proceeds are less than the written-down value of the plant item, for example if the assets are underinsured.
Because insurance proceeds are usually replacing an older asset with a new item, often they will be more than any un-deducted amounts, effectively eliminating any claim for the scrapped/destroyed asset.
Then, depending on the individual’s scenario, there may be rollover relief available. According to the Income Tax Assessment Act 97 (ITAA 97), which covers involuntary disposal of assets, rollover relief is used when insurance payouts are higher than the un-deducted values. Normally these surplus proceeds are treated as assessable income (as mentioned above), however rollover relief allows the owner to offset the cost of replaced assets, effectively reducing its ongoing depreciable value rather than being assessed on the excess from the balancing adjustment.
Because of this, often, but not always, the owner will end up with a new asset that has a similar opening value as the written-down value of the destroyed asset.
Depending on each scenario, there may also be a portion of the insurance proceeds that relate to deductible repairs to a rental property. These are included in assessable income as an assessable recoupment and are claimed as a deductible expense.
In a situation where there is no insurance claim, owners of residential investment properties or commercial buildings can claim depreciation on the new building structure plus the plant and equipment assets starting from construction completion. They can also immediately claim any qualifying un-deducted values remaining for destroyed assets in the year they are destroyed. This process is usually referred to as scrapping and is often used when property owners are completing a renovation or addition.
When an investment property is destroyed, there are many variables that can affect the owner’s taxation and depreciation outcome. To ensure all benefits and tax liabilities are accurately assessed during a natural disaster, it is essential that property investors speak with a trusted accountant and a specialist Quantity Surveyor.