Edited version of private advice

Authorisation Number: 1052276184537

Date of advice: 2 August 2024

Ruling

Subject: Rental property demolition deductions

Question 1

For each of the spouse's 50% ownership share, are the spouses able to immediately deduct under Division 43 of the Income Tax Assessment Act 1997 (ITAA 1997) un-deducted amounts of capital expenditure after voluntarily demolishing the rental property?

Answer

Yes.

As the spouses had un-deducted construction expenditure for the property and the spouses were using the property immediately before destruction for income producing purposes, a deduction for unrecouped capital works is allowable under section 43-43 of the ITAA 1997 for each of the spouse's 50% ownership share.

Question 2

For each of the spouse's 50% ownership share, are the spouses able to immediately deduct under Division 40 of the ITAA 1997 un-deducted amounts of depreciation after voluntarily demolishing the rental property?

Answer

Yes.

As the depreciating assets that were contained within the property were lost or destroyed at the date of destruction and the spouses did not receive an amount for the depreciating assets, the amount the spouses received for the depreciating assets were less than the opening adjustable value, therefore, the spouses can deduct the un-deducted expenditure as per subsection 40-285 (2) for each of the spouse's 50% ownership share.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

This private ruling is based on the facts and circumstances set out below. If your facts and circumstances are different from those set out below, this private ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The spouses jointly owned a property (the property) which was purchased on XX/XX/XX.

The property was rented from July 20XX for approximately two to three years until November 20XX.

The spouses rented the property unfurnished.

The spouses demolished the property and built two townhouses on the land.

The spouses commenced the development process with the builder in January of the last year it was leased.

A deposit was paid to the builder in April 20XX in the same year.

The spouses were advised that the development would be completed within 18 to 24 months from the date of the deposit.

The builder advised in September in the same year as the deposit, that they were on track to demolish the property before Christmas.

The builder advised that before the commencement of the new two houses construction, the existing house would need to be demolished three months prior to allow the land to settle.

The utilities would need to be abolished one month prior to the demolition.

Based on the timeline for the demolition, the spouses did not renew the lease on the property past November 20XX, the same year the spouses engaged the builder.

Emails were provided showing communications between the spouses, the council and the builder.

The spouses had zoom meetings with the builders to discuss delays and processes required to progress the construction.

Due to Covid lockdowns, work from the council offices and the builder were delayed and resulted in backlogs which put your demolition and construction timeline further out of schedule.

The property was demolished in November in the following year from when the tenants vacated the property.

The property remained vacant from November 20XX when the tenants vacated until November the following year when it was demolished.

Fixtures such as sinks, vanities and stove were demolished along with the building.

The spouses did not receive an amount for the salvage of the depreciating assets contained with the property at the date of destruction.

The spouses did not receive any money for the demolition of the property.

The spouses had been claiming deductions for plant and equipment depreciation and capital works prior to the property being demolished.

The spouses have unclaimed balances on the depreciation and capital works schedule.

The build of the two town houses was completed in February 20XX three years after the destruction of the property.

The spouses began renting out unit B in February 20XX in the year of completion.

The spouses will obtain a quantity surveyor's depreciation report which documents each asset in a property and calculates the depreciable value.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 subsection 43-40(1)

Income Tax Assessment Act 1997 section 40-25

Income Tax Assessment Act 1997 subsection 40-25(2)

Income Tax Assessment Act 1997 Subdivision 40-D

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

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

Assumption

It is assumed that you will obtain a depreciation report for the income year of 20XX when the demolition occurred on the property consistent with your stated intentions.

Reasons for decision

Question 1

Taxation Ruling TR 97/25 discusses deductions for capital expenditure on construction of income producing capital works, including buildings and structural improvements. 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 deducted construction expenditure 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 a house 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.

Application to your circumstances

The spouses jointly owned a property which you purchased in 20XX. The spouses leased the property to tenants from July 20XX for approximately two to three years. The spouses engaged a builder in 20XX, the final year of leasing, to demolish the existing property and build two new town houses, one which the spouses would occupy and one which the spouses would lease.

In September 20XX of the final year of leasing, the builder confirmed with the spouses that the demolition was on track to occur before Christmas of the same year. The spouses did not renew the lease on the property in that year and the tenants vacated in November of the same year. Due to Covid lockdowns the demolition did not occur as scheduled. Due to the backlog of work with the council and the builder, the construction timeline was changed therefore the demolition of the property did not occur until November 20XX, a year after the tenants vacated.

The property remained vacant from the period that the tenants vacated until the demolition, therefore the property was used for income producing purposes immediately before being demolished.

As the spouses satisfy all of the conditions set out in section 43-40 of the ITAA 1997 and the spouses did not receive any money for the destruction of the property, the spouses are, for each of the spouse's 50% share, entitled to a deduction for the balance of the spouse's unrecouped capital works in the year that the property was demolished.

Question 2

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 40-300(2) of the ITAA 1997 contains a table of the termination values of certain balancing adjustment events. Item 8 is where a depreciating asset is lost or destroyed and column three determines that the termination value is the amount or value received or receivable under an insurance policy or otherwise for the loss or destruction.

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 amount you can deduct is the difference between those amounts, and you can deduct it for the income year in which the balancing adjustment event occurs.

Application to your circumstances

In the spouse's circumstances, the depreciating assets that were contained within the property at the date of destruction were lost or destroyed. The spouses did not receive an amount from the demolition company for the salvage of the depreciating assets within the property.

Therefore, the amount the spouses received for the depreciating assets is less than the opening adjustable value of the depreciating assets, subsection 40-285(2) of the ITAA 1997 will apply, and the spouses can deduct for each of the spouse's 50% share, the un-deducted expenditure from the depreciating assets that were destroyed during the demolition.