A client issue illustrates a issue all investors should consider. INSURANCE. OVER-INSURANCE !!!
Have a client who owns a number of IPs. Last year a tenant decided that in a moment of inebreiation that igniting the BBQ botttle was smart. No it wasn't. The property burnt like kindling. Fortunately they had property and LL insurance...Well not quite on review.
The property was fully insured. But here is the area where reality and tax law conflicts so I thought I might share the tax issue so that others can learn.
The property was a house on land. It was insured. Plus site costs. The LL insurance gave loss of rent cover for 1 year on a total loss. Rememeber too that the bank had a mortgage interest on the insurance.
So the building was destroyed. So here are some issues that should provoke some thinking and even some discussion and posts...
1. The building was lost. A total loss. The insurer agrees to pay $150K
2. The LL policy agrees the tenant loss of income occurs. It pays a year rent $300pw x 52 = $15,600
3. The insurer pays a total loss of $170k lets agree.
4. The insurer pays the mortgage provider $160K to clear the loan.
5. Loan payout triggers break costs and discharge costs + legals and interest penalties.
The QS Depn Reports shows a lifetime Cap Allow + Depn claim of $50,000 that is yet to be claimed.
SO WHAT HAPPENS ?
1. The insurance policy of LL pays the years rent in advance. Limited expenses. NO DEPN and NO Cap allowance. No interest (loan paid out on loss). etc. Damn a tax problem. positive geared....
2. The building insurance pays the $170K. Owner pays out loan. Almost nothing left in cash. Just $10K - The lender agrees this is suitable for the land security.
Problem now is that the $150K payout (for the building loss) is an assessable income amount. It is reduced by the WRITE-OFF of the remaining depreciation report items for Cap Allowance + Depreciation. Just $50K. Leaving $100K assessable. (50% CGT discount applies). So a tax problem of $30K potential tax due....Tax bills arent deductible.
This is where tax world + real world end. In real world the assessable $150K is reduced by just $50K...Leaving $100K assessable. A potantial assessable amount. It "MAY" be subject to CGT discount but that still leaves $50K taxable....
Catch !! : If the replacement building is rebuilt within 12 months (lol) or they seek Commr approval the replacement can be a substitute CGT asset but its cost base (and eligibility for cap allowance) is reduced by the assesable amount...So the new $200K replacement has limited $50K capital allowance (40 years) OR tax is paid on $150K and then deductions claimed on $200K.
Me thinks this sucks. Loss of $150K @ 2.5% occurs. (Los ofd cap allowance) Reason to over insure ?? Worth revisit of what a "total loss" means.
I would suggest clients rethink the insured value so that it includes taxes !! Who knows what their possible CGT bill is ??? An area that highlights good advisers and tax advice. Also importnace of LL insurance. But beware of the timing issue. Little or no deductions. So inflate that too for the tax.
Have a client who owns a number of IPs. Last year a tenant decided that in a moment of inebreiation that igniting the BBQ botttle was smart. No it wasn't. The property burnt like kindling. Fortunately they had property and LL insurance...Well not quite on review.
The property was fully insured. But here is the area where reality and tax law conflicts so I thought I might share the tax issue so that others can learn.
The property was a house on land. It was insured. Plus site costs. The LL insurance gave loss of rent cover for 1 year on a total loss. Rememeber too that the bank had a mortgage interest on the insurance.
So the building was destroyed. So here are some issues that should provoke some thinking and even some discussion and posts...
1. The building was lost. A total loss. The insurer agrees to pay $150K
2. The LL policy agrees the tenant loss of income occurs. It pays a year rent $300pw x 52 = $15,600
3. The insurer pays a total loss of $170k lets agree.
4. The insurer pays the mortgage provider $160K to clear the loan.
5. Loan payout triggers break costs and discharge costs + legals and interest penalties.
The QS Depn Reports shows a lifetime Cap Allow + Depn claim of $50,000 that is yet to be claimed.
SO WHAT HAPPENS ?
1. The insurance policy of LL pays the years rent in advance. Limited expenses. NO DEPN and NO Cap allowance. No interest (loan paid out on loss). etc. Damn a tax problem. positive geared....
2. The building insurance pays the $170K. Owner pays out loan. Almost nothing left in cash. Just $10K - The lender agrees this is suitable for the land security.
Problem now is that the $150K payout (for the building loss) is an assessable income amount. It is reduced by the WRITE-OFF of the remaining depreciation report items for Cap Allowance + Depreciation. Just $50K. Leaving $100K assessable. (50% CGT discount applies). So a tax problem of $30K potential tax due....Tax bills arent deductible.
This is where tax world + real world end. In real world the assessable $150K is reduced by just $50K...Leaving $100K assessable. A potantial assessable amount. It "MAY" be subject to CGT discount but that still leaves $50K taxable....
Catch !! : If the replacement building is rebuilt within 12 months (lol) or they seek Commr approval the replacement can be a substitute CGT asset but its cost base (and eligibility for cap allowance) is reduced by the assesable amount...So the new $200K replacement has limited $50K capital allowance (40 years) OR tax is paid on $150K and then deductions claimed on $200K.
Me thinks this sucks. Loss of $150K @ 2.5% occurs. (Los ofd cap allowance) Reason to over insure ?? Worth revisit of what a "total loss" means.
I would suggest clients rethink the insured value so that it includes taxes !! Who knows what their possible CGT bill is ??? An area that highlights good advisers and tax advice. Also importnace of LL insurance. But beware of the timing issue. Little or no deductions. So inflate that too for the tax.
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