Depreciation changes for investment property

 

Depreciation changes for investment property

This article has been provided by BMT Quantity Surveyors BMT Quantitiy Surveyors logo

 

 

This month, the government released draft legislation regarding the proposed changes to plant and equipment depreciation as announced in the May federal budget.

The draft outlined further details around a property investor’s eligibility to claim depreciation and provided a range of scenarios to be aware of should this legislation pass.

In a positive move, the government has provided the public with an opportunity to have their say on the new measures, with public consultation open until the 10th of August 2017.

While these measures are yet to be legislated, we have taken a proactive approach in reviewing how these intended changes could impact investors. Following is an in-depth look at the possible outcomes.

Limiting depreciation on second-hand assets

Section two of Treasury Laws Amendment (Housing Tax Integrity) Bill 2017 advises that the Bill intends to amend the Income Tax Assessment Act 1997 (ITAA 1997) to limit deductions for plant and equipment in residential premises.

In essence, the proposed new law reduces the amount an investor can deduct for a previously used depreciating asset for the purpose of gaining or producing assessable income.

Should the proposed legislation be passed, this means that residential property investors won’t be able to claim depreciation for plant and equipment assets found in second-hand properties in which contracts exchanged after 7:30pm on the 9th of May 2017.

Investors can learn more about the proposed changes, who is affected and what they mean by visiting our blog post, ‘What do the proposed changes to depreciation mean for you?’

Capital gains tax changes and implications

The draft legislation outlines some detail around a reduced Capital Gains Tax (CGT) liability for property investors.

Any property investor who is unable to claim depreciation on previously used plant and equipment due to these amendments will be able to claim a capital loss for the decline in value of the plant and equipment assets. This capital loss will only be able to offset a capital gain and if needed can be carried forward to offset future capital gains.

A value that relates to the previously used depreciation assets will need to be established at the time of purchase. A decline in value will then need to be calculated for the assets so that a termination value can be determined at the time the property is sold. The difference between the value at the time of purchase and the termination value will be the capital loss which will reduce the owner’s CGT liability.

How will the changes affect an investor’s cash return?

The following scenario compares the cash return an investor will receive for a three year old house purchased for $600,000 both before and after the proposed new measures.

In the example, the owner receives a rental income of $560 per week or a total income of $29,120. Expenses for the property, such as interest, council rates, property management fees, insurance and repairs and maintenance total $41,028.
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In scenario one, the owner is able to claim a total depreciation claim of $12,397 for both capital works deductions and plant and equipment depreciation.

Using depreciation, this investor will experience a weekly cost of $56 per week to hold the property.

In the second scenario, as the owner exchanged contracts on the property after 7:30pm on the 9th of May 2017, they are only able to claim $6,126 in capital works deductions and will be unable to claim $6,271 in plant and equipment deductions.

This reduced claim would result in the investors weekly cost of holding the investment property increasing from $56 to $101, a difference of $45 per week or $2,340 in the first full financial year.

As you can see, the proposed changes will limit the depreciation deductions available to property investors, which will lead to a cash flow reduction each year.

While we believe that generally the integrity measure has merit, the proposed changes go much further than what is necessary to deliver on the Government’s intention of stopping subsequent owners from claiming deductions in excess of an assets value. The approach proposed in the draft legislation treats residential property investors differently by extinguishing a property investor’s ability to claim a deductions based upon a transaction.

We believe this is caused by gaps in current legislation around establishing a depreciable value for second-hand plant and equipment.

BMT Tax Depreciation will be making a submission detailing this concern along with suggestions of alternative methods which will better resolve this integrity issue.

To view the draft legislation and make a submission click here.

Negative gearing at 4 year low

The cost to the federal budget of  negatively geared rental property deductions has fallen 12.5 per cent to $10.9 billion, the lowest level in four years because of record low interest rates.

A the start of a federal election campaign in which negative gearing will be a key issue, the latest Tax Office statistics show the country’s two million landlords claimed interest deductions of $21 billion, a decline of 9 per cent, while earnings from rents were flat at $38 billion.

The figures, published on Friday and based on taxpayer’s 2013-14 tax returns, show 62 per cent of landlords are returning net losses, down from 64 per cent the year before.

A record 776,672 taxpayers earned a net profit from their investment property in fiscal 2014, an increase of 44,322 people compared with the year before.

 

Capital gains jump $4b

The Tax Office statistics show net capital gains being reported by taxpayers jumped 37 per cent to $14.4 billion, far faster than the rise in the property or stock markets.

The big rise was because losses from the global financial crisis have now washed through the system, inflating the level of gains.

 

ATO clearance certificate to sell your home

From 1 July 2016 there is a 10% non-final withholding tax on payments made to foreign residents that dispose of certain taxable Australian property.

10% non-final withholding tax on payments made to foreign residents that dispose of certain taxable Australian property.

Assets affected

This withholding is limited to taxable Australian property, being:

  • Real property in Australia – land, buildings, residential and commercial property;
  • Mining, quarrying or prospecting rights;
  • Interests in Australian entities that predominantly have such assets – this is called an indirect interest.

Exclusions

There are a number of exclusions. If the foreign resident vendor falls within one of these categories then the 10% withholding is not applicable:

  • The new withholding regime will not apply to real property transactions valued under $2 million, ensuring that the vast majority of residential house sales will be unaffected by this measure;
  • Transactions on an approved stock exchange;
  • The foreign resident vendor is under external administration or in bankruptcy.

Clearance certificates

The Bill introduces a clearance certificate model to provide certainty to purchasers regarding their withholding obligations. The clearance certificate confirms that the withholding tax is not to be withheld from the transaction.

For real property transactions valued above $2 million, the purchaser must withhold 10% of the purchase price unless the vendor shows the purchaser a clearance certificate from the ATO. This certificate can be provided to the purchaser on or before the settlement of the transaction. Where a clearance certificate is provided, the purchaser is not required to withhold an amount from the purchase price.

If the vendor fails to provide the certificate by settlement, the purchaser would be required to withhold 10% of the purchase price and pay this to the ATO. 

This means Australian resident vendors of real property above $2 million will be required to apply for a clearance certificate to ensure no funds are withheld from the sale proceeds.

The vendor may apply for a clearance certificate at any time at which they are considering the disposal of real property. This can be before the property is listed for sale and is valid for 12 months.

The ATO is implementing an ‘automated’ process for issuing a clearance certificate from withholding. This would involve:

  • the vendor (or their agent) completing an online application form;
  • the information on the application being automatically checked against information held by the ATO to assess if the vendor should be treated as an Australian tax resident for the purposes of the transaction; and
  • the automatic issuance of a clearance certificate which removes the need for the purchaser to withhold the 10% from the sale proceeds.

In straightforward cases where the ATO has all the required information, it is expected that clearance certificates will be provided within 1 – 14 days.

Where there are data irregularities or exceptions, some limited manual processing may be required and the clearance certificates could be provided within 14 – 28 days. Higher risk and unusual cases may also require manual intervention which could take longer.

Paying and reporting withholding amounts

Where a withholding obligation exists, the purchaser must pay the withholding amount to the ATO at settlement (i.e. 10% of the purchase price).The penalty for failing to withhold is equal to the amount that was required to be withheld and paid.