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Ruling

Subject: Insurance recovery for malicious damages

Question 1

Is the amount you received as an insurance recovery for damage to your rental property assessable income where you sold your rental property and did not repair the damage?

Answer

No.

Question 2

Does the insurance recovery amount reduce your cost base for capital gains tax (CGT) purposes?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2012

The scheme commences on

1 July 2011

Relevant facts and circumstances

You were the sole owner of a rental property.

The rental property had been rented out to tenant's until it was sold.

The property sustained damage through your last tenants.

You submitted a claim to your insurance company for the damages. The claim was accepted and you received a malicious damages compensation payment.

You decided not to repair the damage and you sold the property in an 'as is' condition.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Subdivision 20-A

Income Tax Assessment Act 1997 Section 20-20

Income Tax Assessment Act 1997 Subsection 20-20(2)

Income Tax Assessment Act 1997 Section 118-300

Reasons for decision

Section 6-5 and section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes ordinary and statutory income derived directly and indirectly from all sources during the income year.

The insurance recovery you received is not considered to be ordinary income.

Statutory income is not ordinary income, but is included in assessable income by specific provisions of the income tax act. Section 10-5 of the ITAA 1997 lists those provisions which give rise to statutory income. For the insurance recovery you received, consideration will need to be given as to whether subdivision 20-A of the ITAA 1997 and the CGT provisions apply.

Subdivision 20-A of the ITAA 1997

Subdivision 20-A of the ITAA 1997 provides that certain amounts received by way of insurance, indemnity or other recoupment are assessable income if the amounts are not income under ordinary concepts or otherwise assessable.

Under subsection 20-20(2) of the ITAA 1997, an amount received as recoupment of a loss or outgoing is an assessable recoupment if the taxpayer:

· received the amount by way of insurance or indemnity; and

· can deduct an amount for the loss or outgoing for the current year, or did deduct or could deduct an amount for the loss or outgoing for an earlier income year under any provision of the Act.

An insurance payout will be an assessable recoupment when both the insurance payout has been received and deductible expenditure has been incurred. In your case you did not make any repairs to your rental property, and you sold the property at a later date in an 'as is' condition.

As you cannot deduct an amount for the loss or outgoing for which the insurance proceeds are received as recoupment, the payment you received for malicious damage to your rental property is not an assessable recoupment under section 20-20 of the ITAA 1997. Therefore you do not include this amount in your tax return as assessable income.

CGT Provisions

There can be a CGT consequence when you receive compensation in relation to an income-producing asset such as a rental property. If the rental property was acquired on or after the 20 September 1985, a capital gain or capital loss may arise on the disposal or part disposal of the asset.

The Commissioner's view on the treatment of compensation receipts is outlined in Taxation Ruling TR 93/35 (TR 95/35). One of the receipt types it addresses is 'compensation for permanent damage to, or permanent reduction in the value of, the underlying asset'.

Permanent damage or reduction in value does not mean everlasting damage or reduced value, but refers to damage or reduction in value which will have permanent effect unless some action is taken by the taxpayer to put it right.

If the payment relates to permanent damage to or permanent reduction in the value of, an underlying asset, the compensation is treated as a recoupment of all or part of the acquisition cost of the asset (that is, you reduce the cost base or reduced cost base by the amount of the compensation). No capital gain or loss arises in respect of the asset until the taxpayer actually disposes of the underlying asset.

In your situation the signing of a contact of sale for your rental property has triggered a CGT event. You will need to subtract the insurance recovery amount from your acquisition costs when you calculate the CGT consequences of the disposal of your income producing asset.

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