Edited version of private advice

Authorisation Number: 1051850310932

Date of advice: 6 July 2021

Ruling

Subject:Rental property - fire damage - insurance proceeds - replacement - depreciating assets - capital works

Question 1

Is a Capital gains tax rollover available for the rebuild of the rental unit if it is used for a similar purpose subject to the incur expenditure within one-year rule?

Answer

Yes.

Question 2

Am I entitled to a capital works deduction on the new build under Division 43 Income Tax Assessment Act 1997, given it was arranged and paid directly by the insurance company under my Body Corporate Insurance Policy?

Answer

No

Question 3

Will the payouts paid for the loss of rental income paid by the insurance company be assessable?

Answer

Yes.

Question 4

Can I claim a depreciation deduction for replacement assets, being the new heat pump and the new hot cylinder, under Division 40 Income Tax Assessment Act 1997 given they were arranged and paid directly by the insurance company?

Answer

No

Question 5

Are you entitled to claim a deduction for the $600 excess on the replacement of the floor coverings and curtains? If yes, is this excess deductible or does it reduce the termination value?

Answer

Yes

This ruling applies for the periods ending:

30 June 2019

30 June 2020

30 June 2021

The scheme commences on:

1 July 2018

Relevant facts and circumstances

You own a rental unit that is one of several units in a complex.

As the rental unit was built in the 19XX's the written down value of the capital works is nil or very close to nil.

The property suffered extensive damage in the year ending xx xxx xxxx.

The resultant damage to the unit was so extensive the rental unit had to be rebuilt from the slab up. The event started in your unit and it was the most significantly damaged, other units in the complex also suffered smoke damage.

Repairs were carried out to repair the damage to the property, together with the replacement of capital works and depreciating assets that were destroyed.

The Body Corporate held a contract of insurance for the property, under which damage by fire was a listed event.

As a result of the damage caused by fire and operation of the contract of insurance, the insurance company paid for repairs to the property, to replace destroyed depreciating assets and to reconstruct destroyed capital works. The amount paid was calculated based on the current replacement value (incorporating construction materials and labour), up to the value insured, of the loss or damage to the rental property.

The insurance amounts received for the destruction of the capital works exceeded the undeducted construction expenditure for those capital works.

Your Insurance company covered the expenses leaving the only out of pocket expenses for you to cover which was the excess relating to the replacement of the carpets and curtains.

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(1)

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

Income Tax Assessment Act 1997 paragraph 20-20(2)(a)

Income Tax Assessment Act 1997 paragraph 20-20(2)(b)

Income Tax Assessment Act 1997 subsection 20-20(3)

Income Tax Assessment Act 1997 subsection 20-25(1)

Income Tax Assessment Act 1997 paragraph 20-25(1)(a)

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 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

Income Tax Assessment Act 1997 section 43-70

Income Tax Assessment Act 1997 subsection 43-75(6)

Income Tax Assessment Act 1997 subsection 43-115(1)

Income Tax Assessment Act 1997 section 43-250

Income Tax Assessment Act 1997 section 43-255

Reasons for decision

Question 1

Summary

The rollover is available as your rental property was destroyed and you received a replacement asset i.e. the unit was rebuilt by the insurance company from the slab up.

Detailed Reasoning

Subdivision 124-B of the ITAA 1997 provides you with the opportunity to choose rollover relief where a CGT asset you own, or part of it, is lost or destroyed.

Section 124-75 of the ITAA 1997 allows you to choose to obtain a roll-over if you receive money for the event occurring and you satisfy the following requirements.

You must incur expenditure

(a)   acquiring a replacement asset, or

(b)   if only part of the asset is lost or destroyed, you incur expenditure of a capital nature repairing or restoring it.

To qualify for the roll-over at least some of the expenditure must be incurred:

(a)   no earlier than one year before the event happens; or

(b)   no later than one year after the end of the income year in which the event happens;

(c)   or within such further time as the Commissioner allows in special circumstances.

If you receive money as a result of the compulsory acquisition, you can only choose a rollover if you incur expenditure in acquiring another CGT asset. Under subsection 124-75(3), you must incur at least some of the expenditure no earlier than one year before the event happens or, within one year after the end of the income year in which the event happens.

Section 124-85 of the ITAA 1997 provides the consequences if you receive money and choose to obtain a roll-over. If the money received does not exceed the expenditure to acquire another CGT asset or to repair or restore the original asset; the gain is disregarded.

The gain is disregarded in working out your net capital gain or net capital loss for the income year. The amount of expenditure that you can include in the cost base of the replacement asset is reduced by the amount of the capital gain.

Application to your circumstances

A rollover is available for you to choose under subdivision 124-B of the ITAA 1997. In order to choose the rollover, you must incur capital expenditure no later than one year after the end of the income year in which the event happened. In your case the CGT event occurred in xx 20XX. You have until the end of the 2020-2021 financial year to incur capital expenditure acquiring a replacement asset or within such further time as the Commissioner allows in special circumstances.

Question 2

Summary

Section 43-40 of the ITAA 1997 allows a taxpayer to immediately deduct, in the income year in which the capital works was destroyed, the amount of construction expenditure that has not yet been deducted, provided the conditions in section 43-40 are met:

As you did not receive an insurance payment for the destruction of the remaining capital works, you are entitled to a deduction for the undeducted construction expenditure of the destroyed capital works but are not entitled to deduct an amount for the new capital works carried out by the insurer.

Detailed reasoning

You can deduct an amount (called a balancing deduction), if all, or part of your capital works are destroyed in an income year, and:

•        you have been allowed or can claim a capital works deduction for the capital works

•        the capital works were used for income producing purposes before they were destroyed, and

•        there is an amount of undeducted construction expenditure for the capital works (section 43-40 of the ITAA 1997).

The amount of the balancing deduction is calculated using the formula set out in section 43-250 of the ITAA 1997. Generally, the deduction is equal to the undeducted construction expenditure at the date of the destruction of the capital works less amounts you have received or have the right to receive for the destruction of the capital works, including an amount received under an insurance policy for the destruction of capital works (section 43-255 of the ITAA 1997).

As the insurer carried out and therefore incurred all the expenditure for the repairs it is considered that:

•        you are not required to reduce the deduction for the remaining amount of construction expenditure when calculating the deduction in the year of the destruction

•        you are not entitled to capital works deductions for the new capital works carried out by the insurer.

Question 3

Summary

Rent and rent-related income is any payment that you get when you rent out your property. You received an insurance payment to compensate you for your lost rent.

Detailed reasoning

If you receive a payout for your rental property as a result of the disaster, you must include this amount as income on your tax return. This includes insurance payouts for loss of rental income.

Further information about rental income you must declare can be found by searching "QC 50170" on ato.gov.au.

Question 4

Summary

A balancing adjustment event occurs for a depreciating asset when it is destroyed.

Where the insurance amount received for the destruction of a depreciating asset is less than its adjustable value, you can deduct the difference.

Where the insurance amount you received for the destruction of a depreciating asset exceeds its adjustable value, the difference is included in your assessable income.

When a depreciating asset is disposed of involuntarily, such as when it is destroyed by fire, you may offset an assessable balancing adjustment amount arising from the involuntary disposal against the cost of a replacement asset.

Detailed reasoning

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).

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.

As the insurer carried out and therefore incurred all the expenditure for the replacement assets being the new heat pump and the new hot cylinder it is considered that:

•        you are not required to reduce the deduction for the remaining amount of depreciation expenditure when calculating the deduction in the year of the destruction

•        you are not entitled to depreciation deductions for the new heat pump and new hot cylinder which were arranged and paid directly by the insurer.

Question 5

Are you entitled to claim a deduction for the $600 excess on the replacement of the floor coverings and curtains? If yes, is this excess deductible or does it reduce the termination value?

Summary

If your Insurance company covered the expenses then you would only be able to claim your out of pocket, which would be the excess

Detailed reasoning

You can claim a deduction for expenses only if you actually incur them and that are not paid by the insurance or your body corporate as part of your contributions.

Further information about rental deductions you can claim can be found by searching "QC 23635" on ato.gov.au.