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Write Off Or Not?

Mark Withers says there is little relief in the Government’s Covid-prompted tax deduction for building expenditure under $5,000, under the low value asset write off rules.

By: Mark Withers

1 November 2020

A deep dive this month into a question that comes up often, a seemingly small matter but one that impacts many investors’ decision-making.

It strikes me as a missed opportunity that the Government would use a heavy stick like the Healthy Homes legislation to force investors to make sensible upgrades to properties (that are in the interests of tenants’ wellbeing), when making a clear statement that certain types of expenditure can be deducted for tax purposes would be added motivation for many investors to undertake such work willingly.

Ambiguity exists and has always existed when it comes to determining whether expenditure on investment properties is deductible repairs or non-deductible and non-depreciable capital improvements. The area is problematic because of extent and degree arguments. And the fact that two sets of circumstances are never the same and that the question of applying the deductibility rules that have been formed by layers of court based precedent decisions are open to professional interpretation.

The Covid relief measures contained precious little for property investors despite them being expected to make rent concessions and limit rent increases to struggling tenants. One initiative the Government did allow though was a deduction for “low value asset expenditure of less than $5,000” where that expenditure is incurred between March 17, 2020 and March 16, 2021. So, let’s look at a two-pronged example and see if it reveals any opportunities for investors?

Example

An investor owns a residential property. They have added an internal wall to split a large room to create another bedroom and have added insulation to the property where none had existed previously. The cost of each work item was less than $5,000 and was incurred within the one-year window for write off of low value asset expenditure.

Is A Full Deduction Allowed

One of the requirements for an immediate deduction under section EE 48 is that “the item has not been and will not become part of any other property that is depreciable property”.

The new wall is part of the depreciable property that already existed, specifically the building itself and is accordingly capitalised to the building cost. No immediate deduction is permitted because the new wall forms part of the building that now carries a nil depreciation rate. Surprisingly, the fact that the depreciation rate is nil does not mean that the building falls outside the definition of depreciable property.

The new insulation is also considered to form part of the building asset as it has no context as an asset unless it becomes part of the building. The commissioner has published Interpretation statement 10/01: “Residential rental properties depreciation of items of depreciable property” which states that insulation is considered to be part of the building and therefore not able to be depreciated separately. As with the new wall addition, the insulation is capitalised as part of the building cost. No immediate deduction is permitted and the residential building depreciation rate of nil will apply.

Interestingly, had the deduction proven allowable, a resulting loss on the property for the tax year would also be “ringfenced” and unable to be offset against other forms of income as a result of the Labour Government’s initiative to single out the property sector with rules specific to only them, all in the mad hope of reducing demand for residential property.

It certainly seems ironic that the same Government that has promoted the Healthy Homes initiative to improve rental stock has failed so miserably to align the tax legislation to achieve their goal of better quality property for tenants and has again failed to deliver any meaningful Covid relief for small investors who are assisting their Covid-impacted tenants.

Their initiative to ring-fence losses has also been undermined by falling interest rates that has ensured most investors with even modest equity in their properties are profitable. Perhaps it’s time for a rethink and a repeal of these rules to ensure consistency and fairness across the investment sector?

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