September 2010 Tax Tips – Special Property Edition

This issue includes:
• Key Dates for September & October
• Types of Rental Expenses
• Hazards of Super Funds Owning Property
• Depreciation Differences: Old vs New Property
• Capital Gains Tax & Impact of Claiming Building Depreciation

Key Dates

• 21 September: August monthly Instalment notice & Activity Statement is due.
• 30 September: Due date for lodgement of 2009 income tax returns for companies or super funds with total gross income of over $2 million. Payment of balance of 2009 tax liability is also due by this date.
• 30 September: Last day of 2009/2010 Fringe Benefits Tax year. Employers should ensure employees keep a record of car odometer readings on this day.
• 21 October: September monthly Instalment notice & Activity Statement is due
• 28 October: September quarter Instalment notice & Activity Statement is due
• 28 October: Super guarantee contributions for September quarter must be made by employers to employees’ fund by this date. 

Types of Rental Expenses

There are three categories of rental expenses – those for which you:
1) cannot claim deductions
2) can claim an immediate deduction in the income year you incur the expense
3) can claim deductions over a number of income years.

Apportionment of rental expenses
There may be situations where not all your expenses are deductible and you need to work out the deductible portion. To do this you subtract any non-deductible expenses from the total amount you have for each category of expense; what remains is your deductible expense.

You will need to apportion your expenses if any of the following apply to you:
• your property is available for rent for only part of the year
• only part of your property is used to earn rent; or
• you rent your property at non-commercial rates.

Property available for part-year rental
If you use your property for both private and assessable income-producing purposes, you cannot claim a deduction for the portion of any expenditure that relates to your private use. Examples of properties you may use for both private and income-producing purposes are holiday homes and time-share units. In cases such as these you cannot claim a deduction for any expenditure incurred for those periods when the home or unit was used by you, your relatives or your friends for private purposes.

In some circumstances, it may be easy to decide which expenditure is private in nature. For example, council rates paid for a full year would need to be apportioned on a time basis according to private use and assessable income-producing use where a property is used for both purposes during the year.

In other circumstances, where you are not able to specifically identify the direct cost, your expenses will need to be apportioned on a reasonable basis.

If you let a property – or part of a property – at less than normal commercial rates, this may limit the amount of deductions you can claim.

Prepaid expenses
If you prepay a rental property expense – such as insurance or interest on money borrowed – that covers a period of 12 months or less and the period ends on or before 30 June 2010, you can claim an immediate deduction. A prepayment that does not meet these criteria and is $1,000 or more may have to be spread over two or more years. This is also the case if you carry on your rental activity as a small business entity and have not chosen to deduct certain prepaid business expenses immediately.

Expenses for which you are not able to claim deductions include:
• acquisition and disposal costs of the property
• expenses not actually incurred by you, such as water or electricity charges borne by your tenants
• expenses that are not related to the rental of a property, such as expenses connected to your own use of a holiday home that you rent out for part of the year.

Acquisition and disposal costs
You cannot claim a deduction for the costs of acquiring or disposing of your rental property. Examples may kind include the purchase cost of the property, conveyancing costs, advertising expenses and stamp duty on the transfer of the property (but not stamp duty on a lease of property. However, these costs may form part of the cost base of the property for capital gains tax (“CGT”) purposes.

You can claim a deduction for these expenses only if you actually incur them and they are not paid by the tenant.

The Hazards of Super Funds Owning Commercial Property

The ATO has recently warned that a Self Managed Super Fund (“SMSF”) holding Business Real Property could be sued if someone is injured or dies because of faults in that property. This is because owners of property have a duty of care to all individuals on their premises.

The super laws provide people with the ability to bring a claim against the trustees of SMSFs to recover loss and damage, which may include action for negligence.

Therefore, if trustees own business real property in their SMSF, they should make sure they are aware, to the best if their ability, of any hazards on their property and, if any hazards do exist, they should have them fixed.

They should also consider having an insurance policy in the SMSF to cover the business property and public liability.

Although the ATO’s focus was on business real property, no doubt the same rationale would apply to residential property.

Depreciation Differences: Old vs New Property

Many investors assume it is not worth getting a depreciation report completed on older properties. While it is true that newer properties contain more deductions than older properties, it is always worth getting some advice about the depreciation potential of an older property.

Older properties

Depreciation on the structure of a building is governed by the date that construction began. This may mean that a property might not be eligible to claim depreciation on the original structure. However, investors will still be able to make a claim on the fixtures and fittings within the building. All eligible assets are valued at the time of settlement regardless of their age. Older properties that have had a renovation are also eligible to claim depreciation on the work completed, even if this work was carried out by the previous owner.

New Properties

Owners of new investment properties are eligible to claim depreciation on the building structure and the fixtures and fittings in their property. The effective life of a new building for ATO purposes is 40 years (some exceptions apply). This means a brand new property is able to claim the entire construction cost over the life of the property. Properties that are not brand new can claim the residual of the 40 years. For example, if an investment property is 10 years old and its owner wants to claim deprivation on the structure, they have 30 years left of deductions to claim.
It is strongly advised to contact a quantity surveyor before starting renovations on a rental property.
If you need assistance in ordering a Depreciation Report for your rental property, please contact us.

Capital Gains Tax & Impact of Claiming Building Depreciation

To work out the net capital gain (or loss) of an asset, you need to know its cost base. With property, the cost base is generally what the property cost the owner plus any improvements or holding costs (not claimed as a tax deduction), buying costs and selling costs.
 
It is also important to note that the cost base must be reduced for any Capital Works Deductions (where the property was acquired after 13 May 1997 or before that date and the construction expenditure was incurred after 30 June 1999) or Capital Allowance Deductions claimed, or to be claimed. This has the effect of increasing the assessable capital gain.

Capital Works Deductions are basically a write-off of certain types of construction expenditure (eg. a building or extension; alterations such as removing or adding an internal wall; or structural improvements to the property such as adding a gazebo, carport, sealed driveway, retaining wall or fence). The amount written off each year will depend on the type of construction and the date construction commenced, but will generally be over 25 or 40 years.

Capital Allowance Deductions are effectively depreciation on property-related assets that fall outside the capital works deduction provisions (eg. fixtures and fittings).

You don’t need to adjust the cost base if you did not claim the deductions and the period for amending the relevant income tax assessment has expired or you do not have sufficient information to determine the amount and nature of the capital expenditure and you do not intend to claim a deduction for any capital works expenditure.

Example
John bought a new investment property in July 2006 for $300,000. He incurred legal fees, commission and stamp duty amounting to $40,000 in total. He sold the property in June 2009 for $410,000. During the period of ownership, he did not make any improvements nor purchase any additional fixtures or fittings. He claimed capital works deductions of $11,000 and capital allowance deductions of $19,000.

Therefore, the cost base for capital gains tax purposes is $310,000 ($300,000 + $40,000 - $11,000 - $19,000). Accordingly, the gross capital gain (before 50% general concession) is $100,000 ($410,000 - $310,000). However, after the 50% general concession, John only needs to declare a net gain of $50,000.

Although, John has to reduce his cost base by $30,000 due to capital works and capital allowance deductions claimed, only 50% of this adjustment flows through to his taxable income whereas he has received a tax deduction of 100% over the 3 years of ownership. Therefore, it is much more tax-effective to claim these deductions than not to claim. So, if you have an investment property but have not yet arranged a Tax Depreciation Report, talk to your accountant or a Quantity Surveyor to see if you’re property is eligible.