Capital Works and Tax Deductions for Rental Property Owners
Capital Works Deductions are ways of recouping some of the expenses incurred during certain types of construction done at rental income properties. These expenses are claimed back over a long period, extending over 25 or 40 yearly tax returns, but are subject to certain conditions, as Mr Matthew Mousa, TLK Partners’ property acquisition tax expert, explains.
What are capital works and how are deductions applied?
Capital Works are large and relatively expensive construction projects. Included are adding a building to the property, carrying out extensions like an extra room, making alterations such as removing an internal wall, or doing other structural additions such as building a gazebo, or paving the driveway.
The deductions are normally spread over a period of 25 or 40 years. As in all tax situations, the amount claimed over the extended period cannot end up higher than the total construction expenses at the time the work was done. The investor will end up at receiving the full allowed cost, but it will be in very small increments each year.
Deductions can’t be claimed until the construction is complete, nor for any period when the building was not available to generate a rental income. “This means if it was completed and ready for rental at some point during the first year you want to claim, you will only be able to claim a proportional amount based on how much of the time it was available. The same would apply if at any stage it was stopped from being used to generate a rental income, either permanently, or for a certain period of time,” Matthew says.
The percentage of deduction allowable in any given rental income year is given in tables available in the Australia Tax Office’s Rental Property Owner’s Guide, and is dependent, among other things, on the year of construction, and whether it was built specifically for the purpose of renting.
Total or major destruction of the property
If a rental property is destroyed or severely damaged by fire, or some other disaster, owners are allowed to claim for the portion of their construction expenses they have not yet claimed. The claim must be in the same income year the damage occurred. “However, any amount received from insurance, and any money the owner happened to get from the salvage of the property, must be deducted from this claim,” Matthew warns.
If the property is not completely destroyed, but can be fixed and put to use again as a rental income property, owners are not allowed to claim any deductions for the period the property was not available for rent.
No dual Use of construction costs
If the expense of construction is used as the base for calculating capital works deductions, owners are not allowed to use those same construction expenses as the base for other deductions, such as the decline in value of depreciating assets.
Changes in building ownership
- When a building is sold, the amount of capital works deductions not yet claimed passes to the new owner. But in order to claim it, the new owner must continue use the building to produce rental income.
- If the construction started after 26 February 1992, the previous owner must tell the new owner the cost of the capital works. The new owner then uses those figures to calculate his deductions from that point onwards.
- If, however, the building was not previously used to produce rental income, the previous owner does not have to supply the information. In that case, the new owner must use a professional to provide an estimate, which can be used as a base for the calculation of the capital works deduction.
“Property investors need solid tax advice, prior to making an asset purchase, during the life of the asset and upon asset disposal because the Taxation landscape in Australia is constantly changing,” Matthew concludes.
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