Edited version of private ruling

Authorisation Number: 1011911250448

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Ruling

Subject: Insurance proceeds received for damage to a rental property

Question 1

Is the portion of the amount paid by your insurance company to cover the cost of repairs to your rental property included in assessable income?

Answer

Yes.

Question 2

Is a deduction allowable for the cost of repairs to your rental property?

Answer

Yes.

Question 3

Will balancing adjustment amounts be included in assessable income in respect to depreciating assets that were destroyed?

Answer

Yes, unless you elect to reduce the cost of the replacement assets for depreciation purposes.

This ruling applies for the following period

1 July 2009 to 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts and circumstances

You own a rental property jointly with your spouse.

The property was damaged.

The property was insured.

You made a claim under the insurance policy for the damage to the property.

Your insurance company paid a builder directly for replacement depreciating assets and repairs to the property.

Assumptions

The cost of each replacement asset exceeds the adjustable value of the destroyed asset that was replaced.

Relevant legislative provisions

Income Tax Assessment Act 1997 20-20,

Income Tax Assessment Act 1997 20-25,

Income Tax Assessment Act 1997 25-10,

Income Tax Assessment Act 1997 40-85,

Income Tax Assessment Act 1997 40-285,

Income Tax Assessment Act 1997 40-295,

Income Tax Assessment Act 1997 40-300 and

Income Tax Assessment Act 1997 40-365.

Reasons for decision

Summary

The insurance proceeds paid by your insurance company to the builder are considered to have been paid on your behalf.

The amount paid to cover the cost of repairs is included in your assessable income to the extent that related repair expenditure is claimed as a deduction.

A balancing adjustment event occurred when your depreciating assets were destroyed in the fire. A balancing adjustment amount will be included in your assessable income unless you elect to reduce the cost of the replacement assets for depreciation purposes.

Detailed reasoning

An amount received by way of insurance is an assessable recoupment if it is paid to cover the cost of a deductible expense and the deduction can be claimed in the current year or in an earlier income year (subsection 20-20(2) of the Income Tax Assessment Act 1997 (ITAA 1997)). [Current year means the income year for which you are working out your assessable income and deductions].

If some other entity pays an amount for you in respect of a loss or outgoing that you incur, you are taken to receive the amount as recoupment of the loss or outgoing (subsection 20-25(2) of the ITAA 1997).

Expenditure incurred on repairs to a rental property is deductible under section 25-10 of the ITAA 1997.

In your case, part of the insurance was paid to cover the cost of repairs to your rental property. You are considered to have incurred deductible repair expenditure when the insurance company paid for the work carried out. Therefore, you are entitled to a deduction under section 25-10 of the ITAA 1997 for the expenditure incurred to repair the property.

As you are entitled to a deduction for the repair expenditure in the 2009-10 income year, and you received an amount of insurance to cover the cost of this expenditure, the insurance amount received to cover this expenditure is an assessable recoupment in the 2009-10 income year under subsection 20-20(2) of the ITAA 1997.

You also received insurance proceeds for depreciating assets that were destroyed. A balancing adjustment event occurs when you stop holding a depreciating asset, such as when it is destroyed (section 40-295 of the ITAA 1997).

The amount of the balancing adjustment is calculated by comparing the asset's termination value with its adjustable value (section 40-285 of the ITAA 1997).

The termination value of a depreciating asset that is lost or destroyed is the amount or value received or receivable under an insurance policy or otherwise for the loss or destruction (item 8 in the table in subsection 40-300(2) of the ITAA 1997.

The adjustable value of an asset at a particular time is the opening adjustable value for that year plus any second element costs for the year, less its decline in value for the year up to that time (subparagraph 40-85(1)(c) of the ITAA 1997).

The opening adjustable value of a depreciating asset for an income year is its adjustable value to you at the end of the previous income year (subsection 40-85(2) of the ITAA 1997).

If the termination value of the depreciating asset is more than its adjustable value, the difference is included in your assessable income in the income year in which the balancing adjustment event occurred (subparagraph 40-285(1)(b) of the ITAA 1997).

If the termination value of the depreciating asset is less than its adjustable value, the difference is deductible in the income year in which the balancing adjustment event occurred (subparagraph 40-285(2)(b) of the ITAA 1997).

As the insurance proceeds you received for the destruction of each of your depreciating assets (termination value) is more than the adjustable value of each of these depreciating assets your share of the difference is included in your assessable income.

However, where you stop holding a depreciating asset because it is destroyed you may choose whether or not to include the balancing adjustment amount in your assessable income to the extent that you chose to treat it as a reduction in the cost and/or opening adjustable value of the replacement asset (section 40-365 of the ITAA 1997).

You can only make this choice for a replacement asset if:

· you incur the expenditure on the replacement asset, or you start to hold it:

o no earlier than one year, or within a further period the Commissioner allows, before the balancing adjustment event occurred; and

o no later than one year, or within a further period the Commissioner allows, after the end of the income year in which the balancing adjustment event occurred, and

· at the end of the income year in which you incurred the expenditure on the asset, or you started to hold it, you used it, or had it installed ready for use, wholly for a taxable purpose and you can deduct an amount for it (subsection 40-365(4) of the ITAA 1997).

Based on the information you have provided you meet the abovementioned conditions to make a choice whether or not to include the balancing adjustment amounts in assessable income.

The balancing adjustment amounts will be included in assessable income unless you choose to treat the balancing adjustment amounts as a reduction in the opening adjustable value of the replacement assets.

Joint ownership

As you and your spouse own the rental property jointly, the taxation treatment discussed above applies to each of you according to your ownership interest. That is, you are each entitled to a deduction for your share of the repairs and you are each required to include in your assessable income your share of the insurance amount that related to those repairs.

Also, you are each required to include in your assessable income your share of the balancing adjustment amounts in relation to the destroyed depreciating assets unless you make the election to reduce the cost of the replacement assets for depreciation purposes.