Edited version of private advice

Authorisation Number: 1051853727017

Date of advice: 8 July 2021

Ruling

Subject: Deductions - rental property - capital works

Question

Can capital works expenses not claimed as deductions, in the year they occurred, be included in the cost base of the property when sold?

Answer

Yes

Question

Can you use less than the required 2.5% capital works deduction to bring your taxable income down to the tax-free threshold amount when my income is low?

Answer

No

This ruling applies for the following period

Year ended 30 June 20XX.

The scheme commences on

1 July 20XX.

Relevant facts and circumstances

You own the property (The Property)

The Property is rented at approximately $XXX per week

You are employed as a consultant.

Your total annual income consists of revenue from rental income and the employment income.

Some years your total income before deductions is less than the tax-free threshold therefore capital works deductions are not claimed.

Some years your total income before deductions is slightly higher than the tax-free threshold therefore some capital works deductions are claimed.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 110-45

Income Tax Assessment Act 1997 section 43-10

Income Tax Assessment Act 1997 section 43-15

Income Tax Assessment Act 1997 section 43-25

Reasons for decision

Question 1

A capital gain is made on the disposal of a capital gains tax (CGT) asset when the proceeds received from the sale are more than the cost base of the asset. Accordingly, to determine the extent of any assessable gain, it is necessary to determine the cost base of the asset.

Section 110-25 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the cost base of a CGT asset has five elements. These include the initial cost of the asset, as well as certain other costs associated with acquiring, holding and disposing of the asset. The five elements are:

1.           The money paid, or required to be paid, in respect of acquiring the CGT asset and/or the market value of any other property given, or required to be given, in respect of acquiring the CGT asset.

2.           Incidental costs of acquiring the asset, or costs in relation to the CGT event. These costs include stamp duty, legal fees, agent's commission and fees paid for professional services. Note that you cannot include these costs if you have or can deduct them.

3.           Non-capital costs incurred in connection with ownership, for example, interest, rates, land tax, repairs and insurance premiums.

4.           Capital expenditure incurred to increase the value of the asset, if the expenditure is reflected in the state or nature of the asset at the time of the CGT event, for example, extensive renovations undertaken to the CGT asset.

5.           Capital expenditure incurred to preserve or defend the title or rights to the asset.

As you will note in element 3 above, subsection 110-25(4) states out that the third element consists of the costs of owning the asset you incurred but only if you acquired the asset after 20 August 1991.

Section 110-45(1B) explains that expenditure does not form part of the second or third element of the cost base to the extent that you have deducted or can deduct it.

In addition Taxation Determination TD 2005/47 specifies that, where an amount that could have been deducted was not deducted, a taxpayer cannot include the amount (that could have been deducted) in the cost base of a CGT asset if the period for amending the income tax return to which the deduction relates has not expired.

In your case you are on a limited income which varies above and below the tax-free threshold.

For the income years where your income is below or close to the tax-free threshold you do not need to claim all or some of the capital works deduction.

You are able to include in the cost base of the property the deductions not claimed in your income tax returns for the years where the period for amendment has expired.

Question 2

Deduction for capital works

The capital works provisions allow a deduction for certain capital expenditure on the construction of buildings and other capital works which are used for the purpose of producing assessable income. Eligible construction expenditure is written off over a number of years.

Division 43 of the ITAA 1997 applies to capital works being certain buildings, and also capital works that are structural improvements begun after 26 February 1992. Examples of structural improvements include fences and retaining walls.

The amount you can deduct is a portion of your construction expenditure.

In the case of structural improvements begun after 26 February 1992 the rate of deduction is 2.5%.

However, not more than 100% of your construction expenditure can be deducted.

This imposes a time limit on the period over which your construction expenditure can be deducted.

In your case, the construction expenditure must be written off over a 40-year period, at a rate of 2.5% per year - no changes to the rate of depreciation are allowed.