Capital Loss Rental Property Schedules

I keep getting asked by Tax Depreciation providers if they should do Capital Loss Rental Property Schedules. The answer is almost always no and this is why…

Capital Loss Rules

Some Tax Depreciation preparers have told me that they are going to provide full tax depreciation schedules for every client, even if they can’t claim any depreciation, as they will assist their clients in claiming capital losses. What do they mean by this…

Where the depreciation deductions are denied, if the depreciable asset is sold or scrapped for a loss, this will create a capital loss.

For example, if I buy a rental property for $500,000 and I get a tax depreciation schedule that says the building and land is worth $480,000 and the depreciable assets are worth $20,000, if in three years time I scrap all the depreciable assets I get a $20,000 capital loss if I was unable to depreciate these assets because of the new rules…

But before you get too excited… remember that a capital loss can only be applied against capital gains so if you don’t have any capital gains the loss is worthless.

But before you get too excited… remember that the way you got the $20,000 capital loss was by reducing the cost base of the building and land by $20,000. So when you sell the land and building you will have increased the capital gain by $20,000. You are increasing the gain on the land and building by the same amount as the loss you are creating…

For example:

Tom buys a rental property and under the new rules he cannot claim any Division 40 deductions.

He is told to get a tax depreciation schedule to work out what will be the capital loss on the depreciable assets when he sells the rental property and the report comes back and says of the $500,000 he spent on buying the rental property, $20,000 related to depreciable assets.

Tom therefore treats the cost of the building as $480,000, and from the depreciation schedule says he spent $20,000 on depreciable assets.

Tom sells the rental property for $600,000 two years later and states he sold the land and building for $600,000 and the depreciable assets for $0. Tom therefore makes a $20,000 capital loss on the depreciable assets. But he also makes a $120,000 ($600,000 less $480,000) capital gain on the land and building. The net effect is a capital gain of $100,000.

Tom then realises that if he had not have paid for the depreciation schedule he would have treated the $500,000 he paid when he bought the land and buildings and when he sold the land and buildings for $600,000 he would make a $100,000 capital gain.

Exactly the same outcome. Tom now wants a refund of the fee he paid for the schedule.

Many owners of rental properties will just decide to treat the entire purchase price as the price for the land and buildings as capital gains will only arise when they sell the property.

The only possible potential benefit in getting a schedule is if you scrap the depreciable assets years before you sell the property as the capital loss arises in the year you scrap. But as capital losses can only be offset against capital gains you only get to use the capital losses when you sell something else that has a capital gain… and in many cases this will be the sale of the rental property in a few years time. Once again, no benefit in getting the schedule. And even if there is a benefit, it is merely using the capital loss in an earlier year, so not much of a benefit.

And there could be a loss if you sell the property and keep the depreciable asset. You have increase the capital gain on the land and buildings and will only get the capital loss when you finally scrap the assets.

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About Ken Mansell

As a stay at home Dad most of the week this is my way of pretending I am still the tax counsel of ASX and SEC listed companies, working at big 4 firms, working at the Federal Treasury, on the Henry Review and at Parliament House for the previous government.
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