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Ruling

Subject: Insurance proceeds received for damage to a rental property

Question 1

Are the insurance proceeds you received to cover the cost of repairs to your rental property included in your assessable income in the income year they were received, when no related repair expenditure was incurred?

Answer

No.

Question 2

Are the insurance proceeds you received to cover the cost of repairs to your rental property included in your assessable income in the income year(s) that the related repair expenditure is incurred?

Answer

Yes.

Question 3

Are the insurance proceeds you received to cover the cost of replacement depreciating assets included in your assessable income as part of a balancing adjustment?

Answer

Yes; however, you may choose not to include a balancing adjustment amount in your assessable income with regards to the insurance proceeds that relate to the destroyed depreciating assets. If you choose to do this, the cost of the replacement depreciating assets will need to be reduced to the extent that you choose to treat the balancing adjustment amount as a reduction in the cost and/or opening adjustable value of the replacement assets.

Question 4

Are the insurance proceeds you received to cover the cost of replacing destroyed capital works included in your assessable income?

Answer

No.

This ruling applies for the following period

1 July 2010 to 30 June 2014

The scheme commenced on

1 July 2010

Relevant facts

You own a rental property which suffered considerable flood damage.

The property was insured against flood damage.

Your insurance company sent a building company to assess the damage. You have provided a quotation from the building company which details the work to be undertaken to remedy the damage caused by the flood. This quotation forms part of the arrangement of this ruling.

The building company put forward a work schedule of a number of months to complete the work, starting immediately.

You received compensation from your insurance company for the damage to your rental property. The amount you received was based on the quotation from the building company.

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

Your tenant advised that they would break the lease if major work was undertaken while they were living there; however, the tenant was content to stay and pay full rent if major work commenced after they vacated.

The tenant signed a lease days before the property was flooded, and may extend their tenancy.

The property has been cleaned and minor repairs have been undertaken to make the property habitable.

You intend to carry out the major work to remedy the flood damage when the current tenant vacates the property.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

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 paragraph 20-20(2)(b)

Income Tax Assessment Act 1997 subsection 20-25(5)

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 subsection 40-85(2)

Income Tax Assessment Act 1997 paragraph 40-85(1)(c)

Income Tax Assessment Act 1997 section 40-285

Income Tax Assessment Act 1997 paragraph 40-285(1)(b)

Income Tax Assessment Act 1997 paragraph 40-285(2)(b)

Income Tax Assessment Act 1997 section 40-295

Income Tax Assessment Act 1997 subsection 40-300(2)

Income Tax Assessment Act 1997 section 40-365

Income Tax Assessment Act 1997 subsection 40-365(4)

Income Tax Assessment Act 1997 section 43-10

Income Tax Assessment Act 1997 section 43-40

Reasons for decision

Summary

The taxation treatment of insurance proceeds depends on what the insurance is paid to replace.

The insurance proceeds you received to cover the cost of repairs is included in your assessable income in the income year(s) that the related deductible repair expenditure is incurred.

The insurance proceeds you received to cover the cost of replacing depreciating assets will be included in your assessable income as part of a balancing adjustment unless you choose to treat the balancing adjustment amount as a reduction in the opening adjustable value of the replacement asset(s).

The insurance proceeds you received to cover the cost of replacing destroyed capital works is not included in your assessable income.

Detailed reasoning

Insurance proceeds and repairs

Your assessable income includes income according to ordinary concepts, which is called ordinary income (section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)). The legislation, however, does not define the expression income according to ordinary concepts. 

Ordinary income generally includes three categories, namely, income from rendering personal services, income from property, and income from carrying on a business. Other characteristics of income that have evolved from case law include receipts that:

· are earned

· are expected

· are relied upon, and

· have an element of periodicity, recurrence or regularity.

Ordinarily, an amount paid to compensate for loss acquires the character of that for which it is substituted (FC of T v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; 10 ATD 82).

The insurance proceeds you received to compensate you for the cost of repairs is not income from rendering personal services, income from property or income from carrying on a business. The payment was also a once and for all payment and therefore does not have an element of recurrence or regularity.

Accordingly, the insurance proceeds you received to compensate you for the cost of repairing your rental property is not assessable income under section 6-5 of the ITAA 1997.

Your assessable income also includes statutory income amounts which are not ordinary income but are included in assessable income by provisions about assessable income (section 6-10 of the ITAA 1997).

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 (subdivision 20-A of the ITAA 1997).

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 ITAA 1997). [Current year means the income year for which you are working out your assessable income and deductions].

Therefore, insurance proceeds will be an assessable recoupment when both the insurance proceeds have been received and deductible expenditure has been incurred.

Expenditure incurred on repairs to a rental property is deductible under section 25-10 of the ITAA 1997. Therefore, the insurance proceeds received to compensate you for the cost of repairs are included in your assessable income in the income year(s) you incur expenditure to repair the rental property (and claim the related repairs deduction).

Insurance proceeds and depreciating assets

The insurance proceeds you received to compensate you for the cost of replacing destroyed depreciating assets, is not income from rendering personal services, income from property or income from carrying on a business. The payment was also a once and for all payment and therefore does not have an element of recurrence or regularity.

Accordingly, the insurance proceeds received as compensation for the destruction of depreciating assets is not assessable income under section 6-5 of the ITAA 1997.

As noted above, your assessable income also includes statutory income amounts which are not ordinary income but are included in assessable income by provisions about assessable income (section 6-10 of the ITAA 1997).

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 (subdivision 20-A of the ITAA 1997).

However, if a balancing adjustment is required for property on which you incurred a loss or outgoing, no part of the termination value of the property is an amount you receive as recoupment of the loss or outgoing (subsection 20-25(5) of the ITAA 1997). The termination value is usually the amount you receive because of disposal, loss or destruction of the property.

Therefore, the insurance proceeds you received for the destruction of your depreciating assets are not an assessable recoupment, as the amount you received is the termination value of the destroyed depreciating assets.

When you stop holding a depreciating asset, such as when it is destroyed, a balancing adjustment event occurs (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 (paragraph 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 (paragraph 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 (paragraph 40-285(2)(b) of the ITAA 1997).

As the insurance proceeds received for the destruction of each of your depreciating assets (termination value) was more than their adjustable value, the difference is an assessable balancing adjustment amount and 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 (section 40-365 of the ITAA 1997), 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.

Therefore, provided you meet the abovementioned conditions, you will be able to make a choice whether or not to include the balancing adjustment amounts in your assessable income.

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

You have indicated that you may not have all the work done to remedy the damage to your rental property, including the replacement of depreciating assets that were destroyed, until after your current tenant vacates the property. One of the conditions to choose 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 is that you must incur expenditure on, or start to hold a replacement asset, no later than one year after the end of the income year in which the balancing adjustment event occurred.

In your case, you must incur expenditure on, or start to hold a replacement asset, no later than 30 June 2012. If you are unable to meet this condition then you should write to the Commissioner and request that the period to incur expenditure on, or start to hold a replacement asset, be extended for a further period.

Insurance proceeds and capital works

The insurance proceeds you received to compensate you for the loss of capital works is not income from rendering personal services, income from property or income from carrying on a business. The payment is also a once and for all payment and therefore does not have an element of recurrence or regularity.

Additionally, the insurance proceeds were received for the loss of capital works and, therefore, take on the character of those capital works. As such, the payment is capital in nature.

Accordingly, the insurance proceeds you received to compensate you for the loss of capital works is not assessable income under section 6-5 of the ITAA 1997.

As noted above, your assessable income also includes statutory income amounts which are not ordinary income but are included in assessable income by provisions about assessable income (section 6-10 of the ITAA 1997).

Under paragraph 20-20(2)(b) of the ITAA 1997, recoupment of a loss or outgoing is only an assessable recoupment if the taxpayer can deduct an amount for the loss or outgoing for the current year, or has deducted or is able to deduct an amount for it for an earlier income year, under any provision of the ITAA 1997.

The phrase 'for the loss or outgoing' in paragraph 20-20(2)(b) of the ITAA 1997 requires a connection between the deduction and the loss or outgoing for which the taxpayer had been recouped (paragraph 11 of Taxation Determination TD 2006/31).

In your case, the relevant loss or outgoing which has been recouped is the destruction of the capital works. The 'loss or outgoing' referred to in paragraph 20-20(2)(b) of the ITAA 1997 is not limited to an amount expended or paid by you. As in the present case, it extends to a loss incurred as a result of the destruction of an asset.

Whilst you may have been able to deduct an amount in relation to the original construction of the capital works under section 43-40 of the ITAA 1997, or in relation to the construction of replacement capital works under section 43-10 of the ITAA 1997, these are not deductions for the loss referred to in paragraph 20-20(2)(b) of the ITAA 1997. No deduction is available for the loss of the capital works.

Accordingly, as you cannot deduct an amount for the loss or outgoing for which the insurance proceeds are received as recoupment, the insurance proceeds received for the destruction of the capital works are not an assessable recoupment under section 20-20 of the ITAA 1997.

As the insurance proceeds paid to cover the cost of reconstructing the capital works that were destroyed in the flood are not ordinary or statutory income they are not included in your assessable income under any provision of the ITAA 1997.