Depreciation

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From: Rob Millington


My accountant suggests that claiming fittings as a depreciation with an IP has an effect on the capital gains tax applied when the IP is sold.
ie. 120k purchase price, depreciate 20k for fittings over time. When sold, say 10 yrs., then the original purchase price is reduced by 20k due to depreciated fittings. The capital gain is then calculated from that figure. Property value - 100k = Gain.

Have I had the correct advice? If so are there any suggestions to alternative approaches?
My accountant also suggested that a P&I loan was a better alternative with an IP. This makes me think he does not fully understand property investment. Any good property accountants in Adelaide?
 
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Reply: 1
From: Dale Gatherum-Goss


Hi

Yes, your accountant was correct with regard to CGT. This is a relatively new rule and shows that he is up to date with the CGT rules.

As to P&I . . . I think it's more of a personal position rather than a professional one. Being a conservative fellow (well, he is an accountant!) it follows that he would
be more comfortable with P&I rather than interest only.

As always, there are good arguments for both thinking and I believe that you should play within your own rules and not worry too much about what your accountant thinks on subjects that are not legally related.

Cheers

Dale
 
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Reply: 2
From: Terry Avery


One of you has it half right but it is not fittings which affect the
calculation of capital gain. The depreciation of fittings has nothing to do
with the capital gain calculation because their life is shorter than the
building.

Building depreciation (otherwise known as capital allowance) of 2.5% p.a.
over 40 years is taken into account with properties purchased after 21 Sep
1999 (I think, you will need to check dates on the ATO website to confirm).
You have a choice to claim the capital allowance or not. Most negatively
geared, buy, hold and never sell investors claim the deduction (otherwise
they can't afford to do it).

So if you claim the capital allowance each year and then sell the house the
ATO claws back the depreciation. For example, you buy a house for $200,000
and claim $2,500 building depreciation a year for ten years and then sell
for $300,000. Your capital gain is $300,000 - ($200,000 - (10 x $2,500)) or
a gain of $125,000. You are then taxed on that gain not the difference
between selling and buying price ($300,000 - $200,000 = $100,000). So if you
claim building depreciation and sell you pay tax on the $25,000 the tax man
gave back to you over the 10 years you owned the property.

If you do not claim building depreciation then you only pay tax on the
$100,000 gain (using the example above).

So your accountant is half right in that depreciation affects your CGT but
it is building and not fittings depreciation that matters.

As to whether you should pay IO or P&I that is a matter of opinion and what
you are comfortable with.

Cheers
 
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Reply: 2.1
From: Sergey Golovin


Accounting is relativly new field for me.

So, the more you claim deductionts and depriciations over the period of time the greater the Capital Gain at the end of the "hold" period and the more tax you pay when you sell that property?(following the logic).

The more they will give you now the more they will take back at the end? Is it right?

Serge.
 
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Reply: 2.1.1
From: Waverly Bay


To Dale and anyone else-familiar-with-the-new CGT rules:

If the cost base of the IP is reduced by the depreciation claimed.... then upon sale, is the entire capital gain then subject to the new 50% taxation treatment (assuming all conditions satisfied eg: 1 year holding period )?

Here's a numerical example:
-Cost $1000
-Depreciation $200
-Sale price $3000.
-Assume 1 year hold etc...

What is the tax position on sale:

a) a taxable capital gain of $1000 (ie ($3000-$1000)/2) PLUS a separate depreciation recapture of $200 taxable as ordinary income

or

b) a taxable capital gain of $1,100 (ie ($3000-800)/2).

Are you saying it will be option (b) based on new CGT rules ?

Thanks alot

Waverly
 
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Reply: 2.1.1.1
From: Dale Gatherum-Goss


Hi

It is b. as I understand the rules. However, and I'm just being difficult now, you can also deduct other costs in buying and selling.

And, it will also depend upon whether you invest in an individuals name or through a company or a trust.

Finally, this is the law as it is now. It will change again.


Dale
 
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Reply: 2.1.1.1.1
From: Mike .


I agree with Terry that only the building write-off is considered when calculating the cost base of the IP when sold. This only applies to assets acquired on or after 13 May 1997.

As for Waverly's example, I believe option b) is correct. Bear in mind that, for properties acquired before 21 Sept 1999, work out your CGT liability using both the Indexation method and Discount method then choose the result which provides the lowest net capital gain. For properties acquired on or after 21 Sept 1999, only the Discount method is available for assets held more than 12 months.

Regards, Mike
 
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Reply: 2.1.1.1.1.1
From: Waverly Bay


Thanks for the replies.

Just to clarify, does (b) above involve reducing the cost base of the IP by both building depreciation AND plant/fittings depreciation?

If only the building depreciation is included in the CGT calc (as some of you have suggested), then how is the depreciation claimed on plant/fittings treated on the sale of the IP? If you are saying that it is not taxable as part of the CGT provisions...then is it fully clawed back and assessable as say ordinary income under another part of the tax legislation?

Thanks

Waverly
 
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Reply: 2.1.1.1.1.1.1
From: Rob Millington


Thanks to all for their replies and discussion.

Regards Rob.M
 
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Reply: 2.1.1.1.1.1.2
From: Terry Avery


WB,

The short answer is no, there is no clawback of depreciation on
plant/fittings in the tax legislation.

The longer answer is that the depreciation of plant/fittings has no effect
on sale of the IP. It is not clawed back and assessed as income. Plant and
fittings wear out and have to be replaced. Items such as carpet will end up
with a nil value and you will have to buy a new one and start depreciation
again. It is considered a cost of doing business and hence an allowable
deduction.

The only effect fittings will have is on your sale price. If the property is
well maintained and things like carpet are in good condition then it may add
to the value of the property and hence the sale price. So if you look at it
one way the clawback is in the increased CGT payable on achieving top dollar
on sale. If on the other hand you don't maintain your property and it falls
into the realm of a renovator's delight then you will get a low price which
will reflect the poor state of the fittings.

What I am saying is that there is no direct clawback of depreciation of
fittings but indirectly there may be.
 
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