In this month’s article JULIA HARTMAN, the Founder of BAN TACS – National Accountants Group provides us with tips and advice for those who’ve had their homes or investment properties damaged in the Australian Bush fires of 2019-2020.
If your home or investment property was damaged in the fires, the taxman is lurking behind those new green shoots of regrowth and what a bonanza is to be had.
The ATO can easily administer through already established data matching with land titles offices and insurance companies, while for the average taxpayer, the whole situation is so complex they are bound to be caught in the trap.
Rebuild or Repair Paid for by Insurance
If the insurance company repairs or rebuilds your main residence, i.e. no cash change hands, you do not have to worry if you move straight back in when the rebuild is completed.
The complications begin if the property is not fully covered by your main residence exemption i.e. a rental property.
That is the basis of the rest of this article.
If it is a rental property, the old plant and equipment is neither scrapped nor replaced in your depreciation schedule. You just continue with your current written down values.
If the insurance company rebuilds your investment property, make sure you get all the information you can about the building costs, this will save you the cost of a quantity surveyors report.
The good news here is you can start depreciating the cost of the new build under Div 43 for another 40 years.
This amount cannot include landscaping or any of the demolition costs. If you have previously been claiming building depreciation you cannot scrap the old building i.e. write off any unclaimed building depreciation on the old building. Despite all this your cost base remains the same for capital gains tax purposes.
Insurance Payout and Rebuild
Just a couple of extra things to consider in addition to the above. If the cash payout is less than the remaining unclaimed building depreciation, you can write off the difference.
Now to the capital gains. Note: plant and equipment on which depreciation have been claimed are not part of the capital gains tax calculation other than to remove their values from any sale proceeds or purchase price.
Regarding the CGT cost base, there is a rollover relief under section 124-85 ITAA 1997 that allows you to ignore the fact that the insurance proceeds are more than the cost base of the house.
See formula below to calculate the cost base of the house separate from the land.
If the insurance payout equals your rebuild costs, the rollover means, you effectively carry on with your current cost base ignoring the insurance payout and rebuild costs.
This may mean you have a more valuable house when time comes to sell and that is when the capital gain is recognised on the benefit you received from the insurance company payout.
If it costs you more to rebuild than the insurance payout you add the extra costs to your cost base.
If the insurance payout is more than the rebuild costs, section 124-85 still allows a rollover (i.e. you stick with your original cost base), but only on the portion of the payout used up in the rebuild costs.
Any excess of the insurance proceeds over the rebuild costs will be subject to CGT. That is assuming that the excess of the insurance proceeds is less than the difference between the cost base of the house and the insurance proceeds.
In the unlikely case that it is more, seek professional advice.
So now back to the cash that is left over after the rebuild and the CGT payable on this.
The 50% discount will apply to this capital gain, if the 50% CGT discount would have applied had you sold the house. For example if you have, at the time of receiving the insurance proceeds owned the property for more than 12 months, and it is not owned by a company.
The rollover does not apply in the case of a capital loss. That is if the cost base of the house (ignoring the land) is more than the insurance proceeds (apportionment of the cost base is discussed below).
In this case, the capital loss needs to be taken into account when you receive the insurance proceeds. This may be helpful to offset other capital gains or is simply saved up until you sell the property anyway, even if you do not have any capital gains in the meantime.
If all your investment property needs are some repairs and the insurance company give you the option of accepting cash or they do the repairs, from a tax point of view you are probably better off letting the insurance company do the repairs. That way there will be no tax consequences to you.
Where as, if you organise the repairs yourself, you will need to consider all the rules regarding when repairs are tax deductible, such as not replacing an item in its entirety, making an improvement or making sure you have income in the year the repair is undertaken.
Insurance Payout and You Move On
If the insurance company give you a cash payout and you do not rebuild then you are deemed to have sold the house. A CGT event is considered to have happened at the date you receive the cash from the insurance company.
Your cost base is apportioned between the house and the land. The eventual sale of the land being a separate CGT event.
If this property was your main residence, normally vacant land cannot be covered by a main residence exemption, the only exception is section 118-160 when the main residence has accidentally been destroyed.
Note section 118-160 is optional, you can choose not to cover the land with your main residence exemption if you calculate it, it’s actually sold at a capital loss.
Your cost base is divided between the house and land by the following formula which is set by legislation:
Cost Base of House =
Cost Base x Insurance Proceeds
Insurance Proceeds + Market Value of the Land
There is only an issue if your property is subject to capital gains tax, for example a rental property that is not covered by your main residence exemption. If this formula gives a lower relative cost base to the land compared with the house then you risk being taxed on a capital gain even though overall you made a loss or broke even.
The CGT event for the house happens at the time you receive the insurance payout which is likely to be in an earlier financial year than you sell the vacant land. This means the capital loss on the land cannot be offset against the capital gain on the house.
Expenses During the Rebuild Process
You can continue to claim interest on the loan and other holding costs during the rebuild even though the property is not available for rent. Recent changes to legislation have removed the tax deduction for expenses relating to vacant land even though the intention is to build a rental property.
Fortunately, there is an exception in the case of natural disasters Section 26-102(6)(c) 1997 ITAA. So, if the property was earning income before it was damaged and you intend to earn income when it is repaired or replaced then you can continue to claim all the holding costs as a tax deduction, despite not receiving any income for even the whole financial year.
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Julia Hartman is the founder of the BAN TACS National Accountants Group which has offices on the east and south coast of Australia, from Mackay to Adelaide.
General Advice Warning: This blog is not designed to replace professional advice. It has been prepared without taking into account your objectives, financial situation or needs. You should consider the appropriateness of the advice, in light of your own objectives, financial situation or needs before making any decision as to what is appropriate for you.