Residential Property Investor Deduction Removal
from 1 July 2017
The Treasury Laws Amendment (Housing Tax Integrity) Act 2017 received Royal Assent on 30 November 2017, following a lengthy passage through Federal Parliament since its introduction in September 2017. The new Act introduces the following important Federal Budget measures regarding residential property:
- introduction of a Federal foreign person vacancy fee regime creating a risk of substantial penalties for “foreign person” owners of Australian residential land (including various Australian tax resident entities) – refer our related Tax Astute Snapshot “Residential Property Vacancy Fee and Return from 9 May 2017”; and
- removal of all travel deductions and some depreciation deductions for residential property investors from 1 July 2017 (unless a specific exception applies) – see details below.
Which entities will be affected by
the removed residential property investor deductions?
Subject to the exceptions noted below, the removed deductions will impact investors to the extent they are deriving rental income from “residential premises” (defined in s.995-1 ITAA 1997 and the GSTA 1999 as including houses, apartments, hotel or boarding house rooms and even house boats) with predominant use as residential accommodation. See GSTR 2012/5 - GST Residential Premises for further details.
Importantly, residential property deductions incurred either:
- in the course of carrying on a business; or
- by any of the following taxpayers:
corporate tax entities (e.g. companies and various corporate limited partnerships and public trading trusts as defined in s.960-115 ITAA 1997);
super funds (except self-managed super funds (SMSF’s)); or
widely held unit trusts with >300 members,
will be unaffected by these changes (i.e. current deductibility provisions will continue to apply after 1 July 2017 in these cases). A further specific exception for new residential premises may also apply regarding the depreciation deduction removal – see details below.
Residential Property Investor Travel Deductions
incurred from 1 July 2017
As illustrated below, travel deductions incurred by residential rental property investors from 1 July 2017 (i.e. 2017/18 onwards) will become non-deductible and also unable to form part of the residential property’s CGT cost base (subject to the exceptions noted above). The legislation and ATO website notes that the types of travel costs affected will include, but not necessarily be limited to, travel for inspection, maintenance, rent collection, preparing for second or subsequent new tenants or visits to the managing agent’s office or body corporate meetings.
TIP – the ATO document “Rental Properties – travel expenses” currently details the treatment of residential investor travel deductions and, therefore, the deductions which will be lost from 1 July 2017.
Residential Property Investor Depreciation Deductions
incurred in income years from 1 July 2017
In income years commencing from 1 July 2017, residential rental property depreciating assets (e.g. carpet, air conditioners, dish washers, ovens and more) which are either:
- acquired on or after 7:30 PM AEST on 9 May 2017 (see B below); or
- acquired/held before that time but 100% non-deductible throughout the 2016/17 income year (see A below),
will generally become ineligible for depreciation deductions for tax purposes to the extent that the depreciating asset is used to produce residential rental income and is a “previously used asset” (see C below) which:
- was previously used by a former owner (i.e. effectively ‘second-hand’ to the current owner);
- has been used in the current owner’s residence; and/or
- has been subject to any other non-taxable/non-deductible use by the current owner (unless occasional or incidental).
Where the depreciating asset meets the above timing and usage conditions, depreciation deductions will be replaced with potential capital gains treatment under CGT Event K7 (generally as a capital loss - see ss.104-235 and 104-230 ITAA 1997) at the time when the asset is sold, scrapped, destroyed or otherwise subject to a ‘balancing adjustment event’ (see s.40-295 ITAA 1997) for depreciation purposes. See below the diagram for further details.
NOTE – The above “second-hand” asset rule (see C above) will not remove depreciation deductibility if the prior owner’s use was solely either:
- trading stock use; or
- use in new residential premises (for GST purposes – see GSTR 2003/3 - New Residential Premises).
Off-the-plan purchases for investment purposes, which include depreciating assets in the price paid, are therefore unlikely to be affected by the above non-deductibility rules (see C above).
TIP – The ATO document “Rental Properties 2017” currently details common rental property depreciating assets which will be subject to treatment as a capital loss if the above conditions (and no exceptions) apply.
NOTE – To the extent depreciation deductions are denied under the new legislation, CGT Event K7 will generally give rise to a capital loss [assuming that the asset’s termination value (e.g. market value on disposal, scrapping etc) is less than the asset’s cost]. The difference between cost and termination value will be claimable as a capital loss at the “balancing adjustment event” time (e.g. sale/scrapping etc – see s.40-295 ITAA 1997 for details) to the extent that it reflects amounts not deducted due to the new residential property investor deduction rules or private non-deductible purposes.
If, for example, a residential property investor’s depreciating asset was:
- acquired for $40,000 (cost); and
- then sold or scrapped when valued at $10,000 (termination value),
and its entire decline in value was made non-deductible due to the new residential property investor deduction rules, then a $30,000 capital loss ($40,000 - $10,000) would arise under CGT Event K7 when sold/scrapped etc.
If instead only 25% of the asset’s total decline in value was made non-deductible under the new residential property investor deductions and a further 33.33% represented a private use year (including the entirety of 2016/17 – see A above) then:
- 25% of the $30,000 noted above (i.e. $7,500) would be caused by the new residential investor provisions; and
- a further 33.33%/one-third (i.e. $10,000) would represent the private use period,
such that a total CGT Event K7 capital loss of $17,500 ($7,500 + $10,000) would arise when the asset was sold/scrapped or similar.
Importantly, the above capital loss treatment:
- will mean that Quantity Surveyor reports will remain relevant for all rental properties, either to determine depreciation deduction amounts or capital losses under a future CGT Event K7;
- applies more broadly than originally expected (due to the application to some assets acquired before 7:30 PM AEST 9 May 2017 – see A above);
- can impact any investor type (including SMSF’s) unless that investor is excluded as shown above (e.g. companies).
- will represent a disadvantage to most residential property investors because it reduces an investor’s deductible amounts for negative gearing purposes and replaces it with a capital loss which may only be offset against a current or future capital gain (often a discount capital gain) made by that same investor; and
- may require apportionment if the property is only partially used for residential investment purposes on either:
a time basis (e.g. property use in some years other than for residential rental); or
a floor area basis (e.g. a part commercial/part residential rental).
WANT MORE DETAILS?
In addition to details available at www.taxastute.com.au, Tax Astute clients receive more information and specific details, questions and answers underlying the brief snapshot summary above as a part of their:
- Tax Astute Training Session;
- Tax Astute Final Reference Notes; and
- Tax Astute Detailed Multimedia Recording.
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