Tax Depreciation: Myths and Recent Changes

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1 Ken Mansell In the style of the famous Mythbusters, in this session we will put to rest some of the biggest myths about tax depreciation. These myths can be found in the appendix to this paper. So for the rest of this paper, we will look at what is new in tax depreciation. 2016/17 Budget - Immediate Asset Write Off In the 2016/17 budget to announced that the small business entity threshold will increase from $2m to $10m from 1 July As a result, a business with an aggregated annual turnover of less than $10m will be able to access a number of small business tax concessions from 1 July In relation to tax depreciation schedules, this includes the simplified depreciation rules, including immediate tax deductibility for asset purchases costing less than $20,000 until 30 June 2017 and then less than $1,000. There has been no legislation yet but hopefully we will see this when Parliament sits at the end of August. Taxation Ruling TR 2015/3 Income tax: matters relating to strata title bodies constituted under strata title legislation In this Ruling the Commissioner considers all the tax issues that can arise in relation to strata units. Importantly, the Commissioner considers how we depreciate assets that are common property. He states: 40. the Commissioner will accept, in relation to strata schemes registered under all the State and Territory Acts, that it is the proprietors, rather than the strata title body, that are entitled to the deductions under Division 40 and Division 43 of the ITAA Accordingly, and in respect of all strata schemes, Income Tax Returns can be prepared on the following basis: the strata title body is not entitled to any deductions under Division 40 and Division 43 of the ITAA 1997 in respect of common property (and proprietors will be entitled to deductions in proportion to their lot entitlements to the extent they otherwise meet the remaining requirements in those Divisions).

2 Example: Charlie owns a strata title interest, being a unit in an apartment block. Charlie currently rents out the unit to Karl. Part of the lot entitlements include a right to use or have access to strata title body common property which consists of the garden area, the lifts, stairwells and passageways. It includes depreciating assets. The common property is not used independently of the lot to generate any income. The Commissioner accepts that Charlie is entitled to claim relevant deductions under Division 40 and Division 43 of the ITAA 1997 in his income tax return. Rental properties 2016, Australian Taxation Office, 26 May 2016 The Commissioner has released the 2016 version of this guide. Like all the previous years, the guide explains how to treat rental income and expenses, including how to treat more than 230 residential rental property assets, giving whether Division 40 or Division 43 applies, and if Division 40 applies, what the Commissioner estimates the effective life of a new asset is. There are no changes to the list of assets or the analysis of these assets from the 2015 guide. However, there are a few changes to the guide that we should consider. Valuation of second hand assets The following example has been added (actually, just expanded). Example: Valuation of second-hand assets The Sullivans purchase a rental property with a 6 year old gas hot water system. It is reasonable to apply the Commissioner s effective life determination of 12 years (for gas hot water systems) and treat the asset as having 6 years remaining effective life. If the system cost $1,200 new, it is reasonable to estimate the value of the hot water system was $600 at the time of purchasing the rental property. Therefore, in working out how much they can claim for the decline in value of the hot water system, the Sullivans use $600 as its cost. Apportionment of values between various assets affects the cost base of the property which is subject to capital gains tax. Amounts allocated to the cost of depreciating assets on the purchase of the rental property are subtracted from the purchase price, in order to arrive at the CGT cost base of the rental property. This shows that for second hand assets in a rental property: 1. The Commissioner expects you to not just use effective life in the ruling but reduce it depending on how old the asset already is; and 2. Most importantly, to work out the cost of a second hand asset you should find out what the value of a new depreciable asset is and reduce it based on how old it is and what is its effective life (not by seeing what is left after other parts are valued!)

3 Assets destroyed The following paragraph has been added to this guide. Where the rental property is destroyed, for example by fire, and results in a total loss of the asset, you can deduct an amount in the income year in which the capital works are destroyed for all of your construction expenditure that has not yet been deducted. However, you must reduce this deduction by any insurance and salvage receipts. This is often overlooked, both claiming the undeducted construction expenditure, or forgetting to reduce this by any insurance payments. Taxation Ruling TR 2016/1 TR 2016/1 - Income tax: effective life of depreciating assets (applicable from 1 July 2016) The Commissioner has released his ruling on effective lives of depreciable assets for the year 1 July 2016 to 30 June In this ruling the Commissioner has an estimate of effective life of various new assets that he will accept without further review. In this Ruling, the Commissioner estimates the effective life of thousands of depreciable assets. COMMON MISTAKE: In making his determination, the Commissioner assumes the depreciating asset is new and has regard to general industry circumstances of use. To quote from every yearly ruling and every yearly Rental Property Guide that the Commissioner has ever published In making his determination, the Commissioner assumes the depreciating asset is new and has regard to general industry circumstances of use. Each year the Commissioner makes a Ruling regarding how to determine the effective life of depreciating assets. The previous year rulings are: TR 2015/2 is applicable from 1 July 2015 TR 2014/4 is applicable from 1 July 2014 TR 2013/4 is applicable from 1 July 2013 TR 2012/2 is applicable from 1 July 2012 TR 2011/2 is applicable from 1 July 2011 TR 2010/2 is applicable from 1 July 2010 TR 2009/4 is applicable from 1 July 2009 TR 2008/4 is applicable from 1 July 2008 TR 2007/3 is applicable from 1 July 2007 TR 2006/15 is applicable from 1 January 2007 TR 2006/5 is applicable from 1 July 2006 TR 2000/18 is applicable from 1 July As a general rule, use the ruling or schedule that is in force at the time you: Entered into a contract to acquire the depreciating asset or otherwise acquired it, or Started to construct it.

4 In the 2016 Ruling, there are no changes to common assets that are included in tax depreciation schedules. But In Taxation Rulings TR 2016/1 the Commissioner has update the effective lives for the following industries and industry activities: Bee farming; Coal seam gas extraction; Confectionery manufacturing; Courier pick-up and delivery services; Cured meat and smallgoods manufacturing; Dairy cattle robotic milking machines; Ice manufacturing; Milk and cream processing; Parking services; Postal delivery services; Rental cars; Rigid and semi-rigid polymer product manufacturing; and Hire cars and limousines. Taxation Determination TD 2016/8 Income tax: what is the car limit under section of the Income Tax Assessment Act 1997 for the financial year? The car limit under section of the Income Tax Assessment Act 1997 for the financial year is $57,581. For example: On July 2016, Laura buys a car to which the car limit applies for $60,000 to use in carrying on her business. As Laura started to hold the car in the financial year, in working out the car's decline in value for the income year, the first element of cost of the car is reduced to $57,581. Taxation Determination TD 2016/12 Income tax: capital gains: what is the improvement threshold for the income year under section of the Income Tax Assessment Act 1997? For the income year, the improvement threshold is $145,401. There have also been a series of Private Rulings that we should consider Authorisation Number: You purchased an investment property in 200X and it has been rented until 20XX. During the 20XX financial year the property was damaged by the tenants. You received an insurance recovery amount in relation to the damage. You spent funds on repairs to restore the property to its original condition. You included items of a capital nature in the repairs, including the replacement of the kitchen cupboards, as well as the replacement of kitchen appliances including a dishwasher.

5 The Commissioner states there is no deductions for repairs as they are not repairing but they are replacing. In relation to the dishwasher the Commissioner concluded this is deductible under Div 40 (including a deductible balancing adjustment for the destroyed dishwasher less the insurance). In relation to the cupboards the Commissioner states they are deductible under Div 43 (remember no deduction for the undeducted construction expenditure as the old cupboards were covered by insurance). Authorisation Number: The laminate in the kitchen had peeled back off the bench top due to water penetration near the sink area. This caused the chipboard to swell and the doors to be unaligned. Drawers were also broken. The builder indicated that the entire kitchen would need to be replaced to restore it to a workable condition. The stove was inoperable and the rangehood's electrical insulation had perished and it was a serious risk to any occupants. There was a severe grease build up and it was deemed an excessive fire risk. The builder indicated that the electrical wiring and appliances required repair and replacement. The downstairs bathroom had been leaking for some time. The pipes within the concrete were fractured and water was leaking under the tiles and into the water proofing membrane causing damage to the timber frame. There was also a kitchenette on the adjacent wall which had been leaking into the wall cavity causing dampness and rot. The builder indicated that the entire bathroom needed to be removed to access the plumbing which needed to be repaired. The timber frame of the bathroom also needed to be repaired and the shower recess, vanity, toilet and tiles would need to be replaced as they would be damaged upon gaining access to the frame and plumbing. The kitchenette was not replaced. The concrete floor needed to be lifted to gain access to the plumbing. The guttering around the entire house was blocked and had rotted through. This caused water to enter the wall cavity of the room downstairs and the gyprock and frame needed to be replaced. An internal wall between the garage and laundry was unstable and needed replacing. Two windows on the front upstairs verandah were cracked and needed replacing. It was decided to remove the windows and cladding and install a handrail on the balcony as a less expensive option. Deductible repairs include replacing guttering, replacing some gyprock and frame, replacing an internal wall and window work on front verandah. Capital works deduction for the kitchen and bathroom replacement. Deduction for the decline in value for the stove and range hood. Authorisation Number:

6 Yes Does the management fee you paid in respect of progress payments, building inspections and building supervision form part of your capital works expenditure? Authorisation Number: You purchased a property.the property was rented after purchase. You obtained a report from a licensed quantity surveyor to determine the undeducted construction expenditure and the depreciation and capital works deductions available It was decided that the property would be demolished. At the time of demolition, there were undeducted capital works deductions and undeducted Division 40 deductions for plant and equipment. The tenant vacated the property and the property was destroyed. The demolition was voluntary. It is anticipated that a new building will be constructed on the land. You did not receive any compensation or insurance proceeds for the demolition. You are entitled to a deduction for your share of the undeducted construction costs in relation to your rental property. You are entitled to a deduction for your share of the undeducted Division 40 deductions for plant and equipment in relation to your rental property. Authorisation Number: A special levy from the strata body to repair the common property In consideration of the age of the building and the relatively short period you were in possession of this property, it follows that these items were in a state of disrepair at the time of your acquisition of the property and the repair work did not arise as a result of your renting out of the property. The repairs are addressing a condition that existed at the time of acquisition and is therefore to be treated as initial repairs and capital in nature. The works will result in the building achieving a much better state of repair than it had when you first acquired it in 20XX. Accordingly, you are not entitled to a deduction under section of the ITAA 1997 for expenses incurred. Although you are not entitled to a deduction for initial repairs, expenditure may be deducted under Division 43 of the ITAA 1997.