Capital gains tax and capital loss schedules explained

Depreciation legislation changes were passed in November 2017, which mean some residential property investors can no longer claim the depreciation of second-hand plant and equipment. These changes can also have an impact on the calculation of capital gains tax (CGT) liabilities at the time of removal or sale of an asset.

Clearly explaining these changes and how they could impact your client is essential.

What changes occurred?

The changes to depreciation legislation related to second-hand plant and equipment assets (division 40) found in residential properties where contracts are exchanged after 7:30 pm on 9 May 2017. 

Common examples of plant and equipment assets found include hot water systems, ovens, rangehoods and blinds.

Who isn’t affected?

The changes do not affect investors who buy brand new residential properties, those who purchase and install brand new assets themselves or those who invested in a rental property before this date.

Residential properties held in superannuation plans (other than self-managed super funds), by public trusts, managed investment trusts and corporate tax entities, as well as non-residential and commercial premises, are also unaffected. Additional rules are also stipulated for properties considered to be substantially renovated by the previous owner.

It’s important to make investors aware that the changes don’t affect deductions for the capital works component, or structural and fixed components, of the building (division 43). These deductions typically make up between 80 and 90 per cent of an investor’s depreciation claim.

How do the changes impact CGT?

For affected investors, the changes have implications on CGT at the time of sale or removal of the asset.

Under the new legislation, the acquisition of existing plant and equipment assets can be reflected in the cost base for CGT for subsequent investors.

Although the method of calculating CGT (as shown below) hasn’t changed, investors need to be made aware of the implications of CGT from the outset of purchase, particularly if they are exchanging contracts on a second-hand residential property post-legislation.

The new legislation allows capital losses to be calculated when an asset is disposed of (for example scrapped or sold as part of the sale of the property) for less than its original cost and depreciation claims for the asset were denied because of the changes.

Under the CGT rules, a capital loss can generally be o set against a capital gain and if there is no capital gain in the current year, the capital loss can generally be carried forward and o set against a future capital gain.

What’s involved in calculating a capital loss? 

In order to calculate a capital loss on disposal, the original value or cost of the asset would need to have been determined at the time of purchase.

The asset’s termination value (e.g. selling price or scrap value) would then need to be determined on the disposal of the asset.

The capital loss would be calculated as the difference between the asset’s termination value and its original value or cost, assuming no depreciation amounts for the asset were allowed as deductions.

The calculation of a capital loss is particularly relevant in certain situations, including when an asset is scrapped, where there is a partial or full CGT main residence exemption, and where the contract date and settlement date for the sale of the property occur in separate financial years.

The capital loss amount on the disposal of an asset will include the depreciation amount that could not be claimed by the owner (as a result of the legislation changes).

Further, the capital loss on disposal should be equal to the depreciation amount that couldn’t be claimed in relation to the asset, where the termination value happens to be equal to the asset’s written down value.

However, in accordance with Australian Taxation Office guidelines, an asset’s termination value does not necessarily equate to its selling or market value.

A site inspection of the property by a specialist quantity surveyor is generally required to determine the correct value of assets contained in an investment property at the time of acquisition. This process helps to ensure no items get missed.

How do quantity surveyors assist in the process?

A specialist quantity surveyor will help accountants to ensure all deductions are identified and claimed correctly for their clients under the new depreciation legislation.

Quantity surveyors are recognised under Tax Ruling 97/25 as one of the few professionals with the appropriate skills necessary to calculate the cost of items for the purpose of tax depreciation.

Some quantity surveyors will include a capital loss schedule for the accountant to perform a calculation adjustment for CGT liabilities. Not all depreciation providers include this, so accountants should check with the quantity surveyor on behalf of their client that this will be included when organising a depreciation schedule.

A tax depreciation schedule should be tailored to suit your client’s property investment scenario, ensuring all deductions are maximised.

What happens during renovations?

Any additional work completed by the current owner on the property that is classified as capital improvements can be included in a tax depreciation schedule and claimed as normal. This includes both capital works and plant and equipment.

Qualifying capital works additions (works that commenced construction from 26 February 1992) completed by a previous owner can be included in a tax depreciation schedule and claimed by the current and future owners for the remaining 40 years.

If a property is considered to have been substantially renovated by the previous owner for selling purposes, then an investor can claim depreciation on the new plant and equipment assets along with any new or old qualifying capital works deductions available.

It is important to note that if an entity has previously been entitled to any depreciation deductions for these assets, or if someone lived in the property before it was held by the current owner/investor, then they will not be able to claim any ongoing plant and equipment depreciation on the assets.

All previously used plant and equipment will be excluded from the depreciation schedule. These assets will be included in the capital loss depreciation schedule for the purposes of claiming a capital loss, allowing the owner to adjust their CGT liabilities where applicable.

What deductions are available to investors following the changes?

In a study of tens of thousands of residential depreciation schedules completed by BMT Tax Depreciation in the 2017-18 financial year, the average first year depreciation claim found was $8,121. Furthermore, of those residential properties affected by changes to depreciation legislation, BMT found investors still had an average claim of $5,651 in 2017-18.

With tax time fast approaching, given the significant depreciation deductions still available, it is always worth making an enquiry on behalf of your clients. A quantity surveyor should be able to provide a depreciation estimate over the phone based on the investor’s individual circumstances.

Bradley Beer, CEO of BMT Tax Depreciation