When considering investing in a rental property it is important
to ensure that all details concerned with the cost of the property
being acquired are obtained to enable building and other depreciation
allowances to be claimed.
In many instances I have experienced situations in which the purchaser
of a rental property has not obtained such details, with the consequence
being that unless details are subsequently acquired, the purchaser
may be prevented from claiming these important and significant
deductions.
The building depreciation provisions, which deal with claiming
a deduction for the write-off of building construction costs,
which were previously contained in Division 10D of the Income
Tax Assessment Act, 1936 ("ITAA 1936"), have been rewritten as
part of the Government's Tax Law Improvement Project, and are
now contained in Division 43 of the Income Tax Assessment Act
1997 ("ITAA 1997").
Division 43 applies to all building and other capital works deductions
claimed in the 1998 financial year and future years, regardless
of when the building or capital works were commenced.
Rate of Deduction
Basically, deductions can be claimed for certain capital expenditure
incurred in the construction of new buildings or alterations,
extensions etc made to existing buildings and other capital works.
Deduction rates of either 2.5% p.a. or 4% p.a. apply depending
upon the type of construction undertaken and the date construction
commences.
The applicable types of construction or capital works are:
- hotel
buildings and apartment buildings used for short-term traveller
accommodation;
- industrial
buildings;
- research
and development facilities;
- income
producing buildings and structural improvements;
- environmental
protection buildings and earthworks.
In relation to residential buildings used for rental purposes to
derive assessable income, such as a home unit, the following deduction
rates apply:
- Where
construction commences after 18 July, 1985 and before 16 September,
1987 - 4% p.a.;
- After
15 September 1987 - 2.5% p.a.
As can be seen no deduction is available for building capital
expenditure incurred in respect to residential buildings prior
to 18 July, 1985.
The construction commencement date determines the rate of deduction
to apply. Construction for the purposes of claiming building depreciation
deductions, starts when the first physical step (such as sinking
of pilings or pouring of foundations) commences and not when preliminary
work such as site preparation is first undertaken.
Furthermore, in order to claim a deduction the following needs
to be considered:
- For
construction commencing prior to 1 July, 1997 a deduction will
be allowable where, firstly, the building is currently used
for an eligible purpose and secondly, where the original owner
of the building at the time of construction intended to use
it for a deductible purpose;
- For
construction commencing after 30 June, 1997 a deduction is dependent
upon the actual use by the taxpayer in the relevant year regardless
of the intended use at the time construction started.
Eligible and Ineligible Capital
Expenditure
Expenditure qualifying for this deduction includes preliminary
costs such as architects fees, engineers fees, building approval
fees, and actual construction costs including expenditure on foundation
excavations.
Expenditure which does not qualify for this deduction includes
the costs of acquiring land; expenditure on demolishing existing
structures; on-site preparation costs such as land clearing, levelling,
filling, draining or otherwise preparing the construction site
prior to carrying out excavation works; landscaping; or expenditure
on plant and equipment or other specifically excluded expenditure
which may be claimed under other sections of the income tax legislation.
Calculation of Deduction
In calculating the deduction, depending on the construction commencement
date, the appropriate rate is applied to the cost of the capital
expenditure, with the first claim being made in the financial
year construction is completed and is used for the purpose of
producing assessable income.
The initial year of claiming a deduction will usually result in
a pro-rata claim based on the number of days during the year that
the building or part thereof relating to the construction undertaken,
was used to produce assessable income.
Each year the applicable rate is applied to the construction costs
with the balance of unclaimed expenditure (referred to as "undeducted
construction expenditure" in the ITAA 1997) being carried forward
to the next year, and so on until the entire amount of expenditure
is claimed.
In the case where a property is sold, provided the purchaser continues
to use the property for a deductible purpose (such as for rental
purposes), the purchaser is entitled to continue to claim a deduction
for the balance of the unclaimed or undeducted construction expenditure.
It is important to recognise that the purchase price of a property
has no bearing on the deduction to be claimed, as it is the building
construction expenditure which is the basis of any claim.
In fact, in situations where for instance a significant property
downturn has occurred and one is able to purchase a rental property
for below its construction cost, the construction cost (and not
the purchase price) still serves as the basis for claiming a deduction
for this capital expenditure.
In the case of claiming a deduction for say a home unit which
is rented out, the owner's share of the deduction for building
construction costs (referred to as "your construction expenditure"
in the ITAA 1997) will be based on his or her unit entitlement.
For instance, let us assume a person purchases a home unit for
rental purposes, with a unit entitlement of 110/1000 on 28 October,
1997 for $250,000 and at the time of purchase the home unit is
rented out and continues to be rented out until the end of the
financial year.
Let us further assume that construction commenced on 15 May, 1994
and that the eligible building construction costs of the block
of units was $1,000,000. The allowable deduction for building
construction costs for the year ended 30 June, 1998 is calculated
as follows:
- Applicable
deduction rate is 2.5%.
- Purchaser's
portion of construction costs are 110/1000 x $1,000,000 = $110,000.
- No.
of days during year deduction applies to purchaser
is 245 days.
- Deduction
to be claimed = $110,000 x 2.5% x 245/365 = $1,846.
What To Do When
Construction Costs
Are Unknown ...
Although income tax legislation requires a person who is disposing
of a property to provide the purchaser with sufficient information
(including total eligible construction costs and the amount of
undeducted construction costs) to enable the purchaser to determine
any deduction entitlement, situations may arise where such details
are unable to be provided.
In cases where information is not available a quantity surveyor
or other independent qualified person including one with expertise
within the building construction industry, can be engaged to provide
the required details to form the basis of a claim.
It should be noted that valuers, real estate agents, accountants
and solicitors are not considered suitably qualified.
Conclusion
Being aware of the deductions to be claimed in regard to building
construction expenditure can contribute considerably to the after
tax return on a rental property investment and so should be considered
when deciding on the purchase of a property.
The question as to the construction cost of the property, the
rate of deduction to be applied and the balance of undeducted
construction costs should form part of a purchaser's "due diligence"
prior to acquiring a property which will be used to derive assessable
income.
In relation to the income tax legislation concerning claiming
building cost deductions, complexities can arise and for this
reason it is considered prudent to obtain professional advice.
