In a recent post we touched how depreciation works during the life of investment property ownership and importantly how it can effect CGT/sale. A few clients reached out to us to explain this in further detail.
Breaking down the capital components of property ownership, is important when calculating a capital gain. This involves identifying costs that have accumulated across the life of ownership but not expenses, these are "capital costs".
Depreciation, more specially capital works deductions (div 43), are deductions on the structure of the building, including items that cannot easily be removed such as windows, tiles and electrical cabling.
During the full term of ownership, owners are able to claim a deduction for capital works. These deductions will reduce tax liabilities therefore generating additional cash savings each year.
However, when it comes time to sell an investment property, amounts claimed for Division 43 depreciation must reduce the cost base. This is also the same for capital works expenses that have been claimed as a deduction. These will need to be deducted from the cost base, reducing the "effective" purchase price and adding to the capital gain.
While this sounds bad, if you have kept the property for longer than 12 months, you will only be adding back half the cost due to the 50% CGT discount you might be entitled to claim. As you have been able to claim the full deduction during your ownership, the 50% GCT discount means you will only pay tax on half the gain.
First owners of brand new investment properties can still claim their Division 40 deductions annually, and as mentioned above, those deductions do not come in to play when calculating CGT in the future.
This is a good time to remind property owners that all property records should be kept and maintained until five years post sale. Your main residence (home) is generally exempt from CGT. However, you should keep all records in case circumstances change and it is no longer exempt from CGT.
If you have any questions, please don't hesitate to get in touch and we will be happy to lend a hand.
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