So what does this mean for those with rental properties and those who produce tax depreciation schedules… A lot!
Under the proposed section 40-27, entities may NOT deduct amounts under Division 40 or Subdivision 328-D for depreciating assets used in gaining or producing assessable income from the use of residential premises for residential accommodation.
This on its own means no tax depreciation schedule for rental properties, other than the provision of the the undeducted initial construction expenditure for the 2.5% deduction under Division 43.
However, there are four exceptions. Only in these four situations will you be able to provide a tax depreciation schedule for a residential rental that has more than the one number for Division 43…
Exception 1: The entity wanting to claim the depreciation deduction is a corporate tax entity, a superannuation plan that is not a self managed superannuation fund or a large unit trust (300+ members). But don’t think you should buy all your residential rental properties in a company as if you do you lose the 50% CGT discount, which is generally worth a lot more than the depreciation deductions.
Exception 2: The depreciation deduction arises in the course of carrying on a business. This means the an entity operating a hotel will be able to claim Division 40 deductions. But it is 100% clear at law that a rental property (or even lots of rental properties) are almost never a “business”.
Exception 3: Now we get an exception that we might actually use… The entity held the asset at the first time it was first used or installed by any entity AND the entity has been able to deduct amounts for the decline in value of the asset in all prior income years in which it has held the asset.
We need to show the entity was the first user AND they have only used it in rental properties ever. An asset will be previously used if there has been any prior use of the asset for which the entity that now holds the asset was not entitled to a tax deduction, with the exception of use as “trading stock”. The only entities that hold assets as trading stock are businesses that hold the assets for sale, like Harvey Norman, not your friend.
EXAMPLE: Craig has newly acquired a rental. This apartment is three years old and has been used as a residence for most of this time. Chris acquires with the apartment carpet. He also acquires curtains new from Retailer Co and a washing machine, that he purchases used from a friend, Jo.
Craig also purchases a new fridge, but rather than place this in the apartment, he uses it to replace his personal fridge, that he acquired a number of years ago for his personal use. He instead places his old fridge in the new apartment.
The amendments do not permit Craig to deduct an amount under Division 40 for the decline in value of the carpet, washing machine or fridge for their use in generating assessable income from the use of his apartment as a rental property as both are previously used. The carpet and washing machine are both previously used assets as it is the previous owner or Jo rather than Craig who first used or installed the assets (other than as trading stock). The fridge is previously used as, while Craig first used or installed the fridge, he has used it wholly for purposes other than taxable purposes in prior years.
The amendments do not affect Craig’s entitlement to deduct an amount under Division 40 for the decline in value of the curtains. They are not ‘previously used’ under either limb of the definition.
Exception 4: The entity first came to hold the asset when it was used in new residential premises AND prior to this time, no entity had either resided in premises or been entitled to deduct any amount AND the entity has been able to deduct in all prior income years in which it has held the asset.
What are new residential premises. This is a GST term as GST only applies to new residential premises and commercial residential premises. GST Ruling GSTR 2003/3 ‘Goods and services tax: when is a sale of real property a sale of new residential premises?’ covers what is new residential premises, but the easiest way to establish this is look at the sale contract as it will identify if it is new residential premises in the GST clause, as if it is GST will be payable. No GST payable under the contract, no tax depreciation.
EXAMPLE Hannah purchases off the plan from DevelCo. DevelCo has fitted out the apartment including curtains and furniture prior to settlement and the transfer of title to Hannah. Developer Co has also fitted out the shared areas of the complex.
All of these assets are new at the time of installation. As these assets were first installed by Developer Co, not Hannah, they are previously used and a deduction would not be available under the general rules established by these amendments.
However, a deduction is still available to Hannah for the depreciating assets (including Hannah’s share of the assets installed in the shared areas of the apartment) for the period she holds the assets as:
- The assets have been installed ready for use in new residential premises;
- Developer Co has not claimed any deduction for the decline in value of the assets (and nor has any other entity); and
- No entity has resided in premises in which the assets have been installed.
When does this all apply from?
These rules apply from 1 July 2017 to assets acquired after 7.30 pm on 9 May 2017. So any rental properties purchased after this time will be subjected to these rules (unless the asset was acquired under a contract entered into before this time).
These rules also apply to private assets purchased before this date that are later used in a rental property (like moving fridge from home to rental property as we saw in the first example).
What can I include in a tax depreciation schedule for properties acquired after 9 May 2017?
- Properties that are not residential – Commercial is AOK
- Properties that are held by a company (but they will lose the 50% CGT discount)
- Assets that were bought by the owner from a retailer (trading stock) and always used in a rental property (never used it privately and never lived in the rental property it is in while the asset was in the property)
- Properties that are new residential premises (as evidenced in the contract), AND no one has lived in the residential property before and they have never live in it themselves…
I think item three assets are not going to need a tax depreciation schedule. Why? If I purchased the asset from a retailer I can’t ask anyone to estimate its cost as I know the actual costs. I have an invoice with the actual cost!
I am also worried about where I purchase an asset from a retailer or purchase new residential premises, but I live in the house for one day (or I let an associate live in the house) after the purchase. If I do I get no depreciation. The idea of buy, living in, renovate and rent out means no depreciation deductions.
WHAT YOU MUST ASK BEFORE PREPARING A TAX DEPRECIATION SCHEDULE
Remember, you are putting yourself out as a tax depreciation expert. Therefore, you cannot argue that it is not up to you to establish if your client can claim Division 40 deductions under these new rules. If you don’t ask these questions I imagine the Tax Practitioners Board will stop you from being able to do any more tax depreciation schedules.
So you must ask:
- Did you acquire this property after 9 May 2017? If they purchased it before we can prepare a tax depreciation schedule covering the asset they acquired with the property.
- Is it commercial or residential? No problems if the property is commercial. Just prepare the schedule.
- Is the entity that owns the property a company? No problems if the entity is a company. Just prepare the schedule.
- Is the property used in a business like a hotel? No problems if it is. Just prepare the schedule.
- Does the sale contract confirm the property is “New Residential”? If so, has anyone lived in it before it was rented out by the entity (including the entity)? If it is new residential and no one has lived in it, prepare the schedule.
And if you have not been able to prepare the schedule yet due to any of the answers above, there may be single assets that can be depreciated. So you ask…
- Did you buy anything from a retailer? If you did did you ever use it privately before it was put in the rental property or have you personally used the rental property? But remember, if they did they know the actual cost so you can’t estimate the cost so you then need to ask what the actual purchase price was.
My summary, if it was purchased before 9 May 2017, it is commercial or it is new residential, then you can consider offering to prepare a depreciation schedule covering Division 40. Otherwise it is ineligible for the Division 40 or the entity knows the actual costs so cannot use an estimate cost.