Scrapping when I sell

A common question I receive concerns scrapping deductions for a property which has been rented and earning assessable income for a number of years. The owners decide to demo it and rebuild. Often multiple dwelling on the property.

Is a deduction always available ??

There are divergent views by accountants on this one. Many accountants will argue that you cant scrap assets at any time. I don't agree at all with that view. Provided the property has been earning assessable income the assets which produce the assessable income may be eligible for depreciation and CA claims. If these assets are destroyed or reach the end of their effective life a balancing adjustment deduction MAY be available. This is typically a deduction, not income.

So, if I buy an old property and it doesn't earn rent can I claim scrapping ?? No.
If the tenanted property is acquired and I allow their lease to end, to then demo can I claim a scrapping deduction ?? Possible but it may be a risk. I would encourage personal advice.

So when is a deduction NOT available ?
Where the rental has been demo'd and a new build occurs and the replacement asset is later used to produce further assessable income (rent)then I see no issues with a deduction claim. The basic test of s8-1 is satisfied. There is a cost incurred in earning assessable income. Any interest incurred during the build may also be deductible under Steele's decision.

The concerns I have are when the new build is proposed to be sold. Even just some of the whole rebuild. This is where the divergent views can occur. Allow me to explain

1. End of effective life. A taxpayer is permitted to self-assess the effective life of an asset. This works in two ways. A taxpayer can depreciate at a rate lesser than the ATO Rulings. Or not claim at all. I cant think of a single reason to do this. (There can be catch with capital allowances too) However, often ignored is that any asset can be self-assessed to shorten its life and accelerate depreciation. I caution you should do this ONLY with advice as just randomly accelerating depreciation would see ALL depreciation denied.
An example: You install a hot water heater on 1st jan and propose to demo the site on 1st July after the tenant vacates on 30 June. The effective life is six months. The asset could be written off under the depreciation formula. I would encourage such decision to be well documented as the ATO could easily challenge this. In this example a reasonable position is easily demonstrated.
I recommend self-assessed decisions be made in writing. The QS report is a good written record of the deduction. In other cases a written record of the decision and how the value was determined should be retained. The QS report is always favoured over taxpayer records.

2. Scrap and re-use value. Scrapping deductions must be reduced by the value of assets re-used, recycled or recovery for the scrap value. In the above example if the HWS is re-used in the new build or at home etc it cannot be scrapped. If the HWS is sold on ebay then the depreciation w/off reduced by the scrap value received.

Tip : Scrapping requires DESTRUCTION. If its not destroyed seek advice.

Can I claim the costs for demolition etc. No. However if the demolition involves a recovery value for materials that reduces the demo cost then that recovery (only) must be adjusted for. The demolition cost itself may be a cost for the new build cost base.

3. Do I scrap everything on the last day of the rental producing period ? Arguably yes. That is a reasonable point in time when a factual position can be determined however there is another argument which some accountants raise that the cost base passes through to the new build.

I definitely don't agree with that. The cost base of obsolete and demolished property CANNOT be incorporated into the new build costs. They were destroyed. Specific rules do not allow those costs to pass through if they don't exist. They must be written off...The question is when or if it is deductible ??

The Commissioner readily accepts that scrapping deductions exist. The concern is whether it can be claimed when there is no income producing activity on either side of the build. The prevalent concern is can I claim a deduction if my intent is to sell ??

It depends.... My views:
1. If the property has been rented for a duration then rebuilt and then intention is to sell I would always claim scrapping deductions for fixtures fittings and plant & equipment.
2. I would apportion between the % kept and sold and claim the kept % for remaining capital allowances
3. Only with a private ruling would I claim scrapping deductions for the remaining capital allowance for the % that is to be resold.

Why do I take that view ?? Taxpayers must always be concerned that claiming scrapping could be taken by the Commissioner as a tax benefit if it permits a taxpayer to offset a substantial rental loss against other income. So Part IVA could apply. Deductions lost, penalties and interest applied. Especially if the rental period is a short duration. Or the benefit is significant. etc. For that reason to ensure that the taxpayer prepares a return that cannot be amended later I recommend a binding private ruling where any part of the former property is intended to be sold.

The ATO could also argue that the residual cost of the obsolete assets is a cost that is incurred in the production of ordinary revenue relating to the sale of the new property. Such a cost would defer and be factored into the profit from the sale.

Call me cautious but that's my role. To ensure client deductions aren't subject to possible review and later amendment.
I recently suggested a client of ours (and a SS member) have a chat to Paul.

They had done a demo and rebuild in Perth and we had assessed she was eligible to claim $65K for the value of works disposed of (scrapped). We had sent a QS to inspect the property and it had been rented out before demolition and the new build was also going to rented out.

Her accountant didn't agree, neither did a third party he ran the idea past. I suggested the client contact Paul. He very kindly assisted with an email outlining his understanding of the rules.

It must have done the trick. The result was a very happy investor.

I don't understand that view. If the business operate a machine that made mousetraps they would depreciate it. If it broke down and was irreparable they would scrap it. If its the very property that produces assessable income it must be destroyed so the same principles apply. Its not a CGT event if its a income producing asset. Passive or active ? Tax law doesn't apply a test.

Don't worry it can also work the other way. A potential client approached me - They operated a bus company and sold to a competitor. Didn't get tax advice. They sold the $3m business and the sale was made for the buses (assets). This is common - Buyers want it that way. This meant that the assets produced a profit. It was 100% assessable. No CGT concessions- A company without sml business concessions. Instead the company paid tax. In the excitement of the offer they didn't get early tax advice and it was fatal.

I question if some in tax see this much and others can be afraid to consider ambitious large deductions. I will be honest and say I clearly qualify that NOT ALL taxpayers cleanly fit the scrapping requirements.

A very good example of the requirement to get personal tax advice - early.
In the excitement of the offer they didn't get early tax advice and it was fatal.


A very good example of the requirement to get personal tax advice - early.

It's always nice when things are straightforward: rented before and after the disposal/demolition and improvements. Of course, there are myriad different situations out there as we've seen from recent forum posts.

While Quantity Surveyors are experts at valuing capital works and plant & equipment items, plus we know how to use legislation to maximise deductions, when it's not black and white we always make sure people seek accountant advice. And, as you say, if it's a really thorny one then a private ruling will see people safe rather than sorry.