Edited version of private advice

Authorisation Number: 1052078055944

Date of advice: 3 February 2023

Ruling

Subject: Commercial property - demolition expenses

Question 1

Are you able to deduct under Division 43 of the Income Tax Assessment Act 1997 (ITAA 1997) undeducted amounts of capital expenditure after voluntarily demolishing your commercial rental property?

Answer

Yes.

Question 2

Are you able to immediately deduct under Division 40 of the ITAA 1997 undeducted amounts of depreciation after voluntarily demolishing your commercial rental property?

Answer

Yes.

Question 3

Are you able to deduct from your assessable income the amounts incurred for the voluntary demolition of your commercial rental property?

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 are in the business of leasing commercial property.

You purchased a commercial property at a specified date in 20XX for the purpose of producing assessable income.

After purchase you obtained a quantity surveyor's depreciation report which provided a building valuation and the deductible building allowance and depreciable asset values.

The property was leased to a third party at the time the property was acquired.

The third party requested you develop the existing site as the tenant required a bigger warehouse.

After an extensive design and tendering process with an appointed project manager a letter of intent was provided to a builder.

The tenant vacated the site at a specified date in 20XX.

The site was not used for any other purpose between the period of the tenant vacating and construction commencing.

Demolition of the site commenced at a specified date in 20XX and completed in the same year.

You did not receive an amount for the salvage of the depreciating assets contained within the property at the date of destruction.

You entered into a contract for the construction of a larger warehouse at a specified date in 20XX.

The building achieved practical completion at a specified date in 20XX.

The tenant continued to lease the site during the demolition and build period with the intention of resuming occupancy once the development was completed.

Relevant legislative provisions

Income Tax Assessment Act 1997 subdivision 40-D

Income Tax Assessment Act 1997 section 40-25

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

Income Tax Assessment Act 1997 subsection 40-285(2)

Income Tax Assessment Act 1997 section 43-40

Income Tax Assessment Act 1997 subdivision 43-H

Income Tax Assessment Act 1997 section 43-250

Reasons for decision

Question 1

Summary

If you meet certain criteria deductions for undeducted amounts of capital are available when a property is destroyed. Voluntary destruction is included in the meaning of destroyed. To be eligible, the property needs to have been used immediately prior to the destruction for the purpose of producing assessable income or had not been used since it was used for the purpose of producing assessable income. You used the property for the purpose of producing assessable income up to the tenant vacating and then it remained unused till demolition commenced. You meet the requirements to deduct undeducted amounts of capital expenditure.

Detailed reasoning

Taxation Ruling 97/25 Income Tax: property development: a deduction for capital expenditure on construction of income-producing capital works, including buildings and structural improvements provides guidance around eligibility for capital works deductions. Paragraph 18 states that the Commissioner considers that section 43-40 of the ITAA 1997 applies both to voluntary and involuntary destruction of capital works.

Subsection 43-40(1) of the ITAA 1997 states you can deduct an amount if all or a part of your area is destroyed in an income year and:

(a) you have been allowed, or can claim, a deduction under this Division, or former Division 10C or 10D of Part III of the Income Tax Assessment Act 1936, for your area; and

(b) there is amount of un-deducted construction expenditure for your area; and

(c) you were using your area in the way that applied to it under Table 43-140 (Current year use) immediately before the destruction or if not, neither you nor any other entity used your area for any purpose since it was last used by you in that way.

You have been allowed deductions under Division 43 and there are amounts that have not yet been deducted for construction expenditure. As the requirements of paragraphs 43-40(1)(a) and (b) of the ITAA 1997 have been satisfied the issue to be considered is whether paragraph 43-40(1)(c) of the ITAA 1997 has been satisfied.

Paragraph 43-40(1)(c) of the ITAA 1997 has two limbs. The first limb is satisfied if 'your area' was used immediately before the destruction in a way that applies to it under the table in section 43-140 of the ITAA 1997. The required use for capital works constructed in time period three of the table is that the area is used for the purpose of producing assessable income. If it has not been used for this purpose, then the second limb allows a deduction if no entity has used the area for any purpose since it was last used by the taxpayer for the purpose of producing assessable income.

In considering if the requirements of paragraph 43-40(1)(c) of the ITAA 1997 are satisfied the meaning of 'immediately before the destruction' must be considered. It has been interpreted by the courts and the Commissioner applied this view in ATO Interpretive Decision 2010/35 (ATO ID 2010/35). The Commissioner's view is that 'immediately before' refers to a relatively short period of time between the last use of the area and its destruction.

In your circumstances the property was being used as a commercial rental to produce assessable income. The tenants vacated the property at a specified date in 20XX and the demolition began at a specified date in 20XX. You did not use the property for any other purpose between the tenants vacating and demolition commencing. The period between the tenants vacating and demolition commencing is considered a short period of time. Furthermore, the tenant continued to lease the site throughout the demolition and build process resulting in a constant stream of assessable income from the property.

Therefore, a deduction under subsection 43-40(1) of the ITAA 1997 is allowed for the construction expenditure that has not yet been deducted. As per subsection 43-40(2) the deduction is allowable in the income year in which the destruction occurred and is calculated under section 43-250.

Question 2

Summary

If you meet certain criteria deductions are available for undeducted amounts of depreciation after voluntarily demolishing a property. The property must have been used for a taxable purpose and any asset value reduced for non-taxable usage. Where the termination value is less than the adjustable value a deduction for the difference is available. You have used the property for a taxable purpose and the termination value of your depreciating assets is $0. Where the adjustable value of a depreciating asset is more than $0 a deduction is available for the undeducted amount.

Detailed reasoning

Section 40-25 of the ITAA 1997 allows a deduction for the decline in value (depreciation) of a depreciating asset you hold, to the extent the asset is used for a taxable purpose.

Subsection 40-25(2) of the ITAA 1997 states that you must reduce your deduction by the part of the assets decline in value that is attributable to your use of the asset for a purpose other than a taxable purpose.

Taxable purpose means for the purpose of producing assessable income.

Subdivision 40-D of the ITAA 1997 may allow a balancing adjustment deduction in certain circumstances.

Subsection 40-285(2) of the ITAA 1997 provides that you can deduct an amount if:

(a) a balancing adjustment event occurs for a depreciating asset you held and:

(i) whose decline in value you worked out under Subdivision 40-B; or

(ii) whose decline in value you would have worked out under that Subdivision if you had used the asset; and

(b) the asset's termination value is less than its adjustable value just before the event occurred.

The termination value of a depreciating asset is defined in section 40-300 of the ITAA 1997. Item 8 of termination value table covers the balancing adjustment event where a depreciating asset is lost or destroyed. Item 8 provides that the termination value is the amount or value received or receivable under an insurance policy or otherwise for the loss or destruction.

The amount you can deduct is the difference between the adjustable value and the termination value, and you can deduct it for the income year in which the balancing adjustment event occurs.

In your circumstances, the depreciating assets that were contained within the property at the date of destruction were lost or destroyed. You did not receive an amount from the builder for the salvage of the depreciating assets within the property. The termination value of your depreciating assets is $0. Where this termination value is less than the opening adjustable value of the depreciating assets subsection 40-285(2) of the ITAA 1997 will apply, and you can deduct the undeducted expenditure from the depreciating assets that were destroyed during the demolition.

Question 3

Summary

Expenditure on demolishing structures is not deductable under capital works as it is not a construction expenditure however it is taken into account when calculating deductions for undeducted amounts. Where you receive an amount for the destruction of capital works your demolition expenses are used to offset the lessening of deduction that occurs because that amount has been received for disposing of the destroyed capital works. You did not receive any amount for the destruction of the building and therefor the reduction amount is $0 and demolition expenses are not deductible.

Detailed reasoning

Expenditure on demolishing existing structures is not an amount that can contribute to a deduction for capital works under section 43-10 of the ITAA 1997 as it is not construction expenditure (paragraph 43-70(2)(b) of the ITAA 1997). However, such expenditure may be taken into account in calculating a deduction under section 43-40 of the ITAA 1997.

The amount a taxpayer is entitled to deduct under section 43-40 of the ITAA is determined using the method statement contained in section 43-250 of the ITAA 1997. Under this method statement you are required to reduce your deduction where you have received or have a right to receive amounts for the destruction of the capital works.

Section 43-255 of the ITAA 1997 provides that the amounts you have received or have a right to receive for the destruction of the capital works include:

•         an amount received under an insurance policy or otherwise for the destruction of the capital works, and

•         an amount received for disposing of any property salvaged from the demolition, less any demolition expenditure incurred on the property.

Thus, in calculating the balancing deduction under section 43-250 of the ITAA 1997, demolition expenditure acts to offset the lessening of deduction that occurs because of the fact that an amount has been received for disposing of the destroyed capital works.

ATO Interpretive Decision 2003/833 considers an example where a taxpayer:

•         has $50,000 of undeducted construction expenditure for a building,

•         incurred $5,000 in demolition costs, and

•         did not receive an amount for the destruction of capital works:

Example 3

The taxpayer did not receive any amount for the destruction of the building, and did not receive any amounts for disposing of the destroyed building. The reduction amount calculated as being received under section 43-255 of the ITAA 1997 is zero. The $5,000 excess of demolition expenditure over the amount received for disposing of the destroyed building is not deductible under Division 43 of the ITAA 1997.

The balancing deduction under section 43-250 of the ITAA 1997 is $50,000 ($50,000 - $0).

There may be capital gains tax implications under Part 3-1 of the ITAA 1997 for the balance of the demolition expenditure incurred (in the example, $5,000).

In your case, you are not entitled to a deduction for the demolition expenses you incurred. As you received no amounts for the destruction of the capital works the demolition expenses will not act to increase the deduction available to you under section 43-40 of the ITAA 1997.