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Ruling

Subject: Rental property - insurance proceeds - repairs - depreciating asset

Question 1: Are you entitled to a deduction for the cost of repairs to the depreciating asset?

Answer: Yes

Question 2: Is the insurance amount received to cover the cost of repairs to the depreciating asset included in your assessable income?

Answer: Yes, in the income year that the related repair expenditure is claimed as a deduction

Question 3: Are you entitled to a deduction for the decline in value of the irreparable depreciating asset up until the date it was damaged?

Answer: Yes

Question 4: Are you entitled to a deduction for the adjustable (written down) value of the irreparably damaged depreciating asset?

Answer: No, the adjustable (written down) value is included in the calculation of the balancing adjustment amount for the irreparable depreciating asset.

Question 5: Is the insurance amount received for the destruction of the depreciating asset included in your assessable income?

Answer: No, the amount received is included in the calculation of the balancing adjustment amount for the irreparable depreciating asset.

Question 6: Are you entitled to a balancing adjustment deduction for the irreparable depreciating asset, where its termination value was less than its adjustable value?

Answer: Yes

Question 7: Are you entitled to a deduction for the decline in value of the replacement depreciating asset from the date it was installed and ready for use?

Answer: Yes

This ruling applies for the following period

1 July 2011 to 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You own a rental property.

A depreciating asset in the rental property sustained damage.

You paid for repairs to the depreciating asset.

You received an insurance amount to cover the cost of repairs to the depreciating asset.

After the repairs were completed further damage was identified. This further damage could not be repaired and the depreciating asset needed to be replaced.

You received an insurance amount for the irreparable depreciating asset.

The insurance amount received for the irreparable depreciating asset was less than the adjustable value of the asset.

You purchased a replacement depreciating asset for your rental 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 subsection 20-20(2)

Income Tax Assessment Act 1997 subsection 20-25(2)

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 section 40-25

Income Tax Assessment Act 1997 subsection 40-25(7)

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

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

Income Tax Assessment Act 1997 section 40-285

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)

Reasons for decision

Insurance proceeds and repairs

An amount received by way of insurance is an assessable recoupment if it is paid to cover the cost of a deductible expense and a 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].

Expenditure incurred on repairs to a rental property is deductible under section 25-10 of the ITAA 1997. You incurred deductible repair expenditure when you paid for the repairs to your depreciating asset, and as such you are entitled to a deduction for this expense.

As you are entitled to a deduction for the cost of repairs to the depreciating asset, and you received an insurance amount for this expenditure, the insurance amount is an assessable recoupment under subsection 20-20(2) of the ITAA 1997. The insurance amount you received to cover the cost of repairs is included in your assessable income in the income year that the related repair expenditure is claimed as a deduction.

Section 40-25 of the ITAA 1997 allows you to deduct an amount equal to the decline in value for an income year of a depreciating asset to the extent that it is used for a taxable purpose.

A taxable purpose includes the purpose of producing assessable income (subsection 40-25(7) of the ITAA 1997).

As you used the irreparable depreciating asset to produce assessable income prior to it being damaged, you are entitled to a deduction for its decline in value for the period during the income year it was used for that purpose. That is, from the beginning of the income year to the date it was irreparably damaged.

You are also entitled to decline in value deductions for your replacement depreciating asset to the extent it is used to produce assessable income from the date it was installed and ready to use.

The insurance amount you received as compensation for the destruction of the depreciating asset 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 did not have an element of recurrence or regularity. [Note: a depreciating asset that is irreparably damaged is considered to fall within the meaning of lost or destroyed].

Accordingly, the insurance amount received as compensation 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).

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.

When you stop holding a depreciating asset, such as when it is lost destroyed, a balancing adjustment event occurs (section 40-295 of the ITAA 1997).

Therefore, the insurance amount you received for the destroyed depreciating asset is not an assessable recoupment, as a balancing adjustment is required.

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 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 amount received for the destruction of the depreciating asset (termination value) was less than its adjustable value, you are entitled to a deduction for the difference.