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 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. So please spread this blog around.
Rebuild or Repair Paid for by Insurance:
If the insurance company repairs or rebuilds your main residence, ie no cash changes hands, you do not have to worry if you move straight back in when the rebuild is completed.
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 ie 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 you 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 (ie 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 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, which may be helpful to offset other capital gains or is simply saved up until you sell the property anyway, if you do not have any capital gains in the meantime.
If all that your investment property needs are some repairs and the insurance company give you the option of taking 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 is 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, it 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.
What if You Are Living Overseas?
If you were a victim of the most recent fires then it is imperative that you make sure the insurance company pays you out before 30th June 2020 or they rebuild the house for you. If you take a payout after 30th June 2020, or if you have purchased the property after May 2017, you will completely lose your main residence exemption retrospectively for the whole period you have owned the property. Section 118-160 can’t even help you with the sale of the land unless that happens before 30th June 2020.
If you are not familiar with the new laws removing Expats’ main residence exemptions retrospectively here is a link to a previous blog on the topic https://bantacs.com.au/Jblog/expats-beware/#more-398
Of course, there are many twists and turns with the capital gains tax calculation which would bore you to death here. If you trigger any of the CGT events above, other than in the case of the simple destruction of your family home and sale of the vacant land, you need to seek professional advice.
For a table of items that are considered plant and equipment go to the back of this ATO guide https://www.ato.gov.au/uploadedFiles/Content/IND/downloads/Rental-properties-2019.pdf
- When it comes to your main residence make sure you move straight back in once the rebuild is completed.
- If you are a non-resident of Australia for tax purposes and there was once a main residence exemption on the property there are going to be dire tax consequences unless you allow the insurance company to rebuild or manage to get your insurance payout and the vacant land sold before 30th June 2020.
- If the insurance company gives you the cash to repair your investment property make sure those repairs are undertaken in a financial year that the property earns income. Income can be the insurance payout for the repairs.
- If you receive a payout for your investment property and then sell the land you may get caught with a capital loss on the land and a capital gain on the insurance payout. Unless they both happen in the same financial year or you sell the land before you get the insurance payout, the loss will not be able to be offset against the gain.
- 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 because the good news here is you can start depreciating the cost of the new build under div 43.
- If all that your investment property needs is some repairs, from a tax point of view, you are probably better off letting the insurance company do the repairs. That way you don’t have to worry if the repairs technically qualify as a repair for tax purposes.
- There may be CGT consequences if you receive an insurance payout and rebuild when the rebuild cost is not the same as the insurance payout.