Hi,
I'm brand new to the forum (and the IP game). I've done some reading on here and there are certainly some knowledgable people in these forums so I thought somebody may be able to help?
I found this article on PropertyInvesting.com and was wondering if anyone might be able to shed some light on a particular part (highlighted in red) for me?
Negative Gearing… Friend or Foe?
Often proclaimed as a property investor's best friend, negative gearing is a concept that few people really understand. Sadly this ignorance is causing many investors a lot of financial heartache…..
….The Seven Negative Gearing Truths!….
….Truth #2: The dangers of depreciation
Buying a property based on depreciation benefits is dangerous and deceptive.
Depreciation is an accounting term used to describe the wear and tear of an asset that occurs over time. In practical terms, depreciation on a property refers to the carpet wearing down, the walls becoming chipped or stained and the furniture dating.
In most new properties you are allowed to claim a tax deduction for the depreciation of the fixtures and fittings and in certain circumstances you may also claim a building write-off of either 2.5 per cent or 4 per cent of the property (not land) value too.
Slick marketing companies sell the notion of the taxman paying off your property using depreciation and building write-off deductions, but this sales pitch is quite deceptive because you don't avoid paying tax with depreciation, you just defer it.
Commonsense suggests that depreciating an appreciating asset like property will give you a tax deduction today, but you'll have to repay it in the form of capital gains tax at a later date when you sell.
What does it mean by "you just defer it" and "you'll have to repay it in the form of capital gains tax"?
Would anyone pls care to ellaborate on this?
Thank you in advance
Matt Woodro
Any bean counters here?
As far as I know CGT is based on sale price less the purchase price + what ever the legislation allows (eg hold for more than 12 months, etc).
Depreciation does not impact the CGT payable at all?
Its a bit hard to explain but I'll do my best. Depreciation means the property is reducing in value so if you sell it for more then you must add back all the depreciation you've claimed as the property has increased in value not decreased.
When you sell a property if the contract does not specify how much each asset that you've depreciated is sold for then you'll need to add back the depreciation you've previously claimed as a tax deduction.
To make it easy lets assume Mr X buys a house in 2003 for $300000 + $8000 in stamp duty/legals. He gets in a QS who calculates he can claim $100000 as Capital works (2.5%) and another $20000 contents@ 10%. Prime cost.
2003 $2500 + $2000 = $4500 tax claim
2004 $2500 + $2000 = $4500 tax claim
2005 $2500 + $2000 = $4500 tax claim
2006 $2500 + $2000 = $4500 tax claim
So after holding the property for 4 years he's claimed $18000 as a tax deduction in his tax return.
You decide to sell the property in 2007 for $750000 less selling costs of $20000 = $730000 & do not specify the value of assets.
To work out the CGT
Cost base = $308000,
Sold for $730000 – $18000 = $712000
Net Capital gain = $404000
Less: 50% discount
Total Taxable CGT = $202000 (shared depending on ownership)The $18000 would not receive the 50% discount and would be taxed at your marginal tax rate, so adding on the $202000 thats a total of $220000 to be included in Mr X tax return.
Lets assume Mr X instead contacted his Accountant and included a depreciation schedule with the contract showing the written down value of assets of $120000 – $18000 = $102000. How much would the CGT be:
$730000 – $102000 = $628000
$308000 – $102000 = $206000
Therefore Net CGT is $422000
Less 50% discount
Total taxable CGT = $211000So by including the depreciation schedule in the contract he's saved $9000 from being taxed at his marginal rate which would be 48.5% = $4365. So who's going to phone their Accountant next time BEFORE they sign a contract of sale?
Further to that great post Amanda,
the depreciation is only added back on if you sell.
So if you never sell, but keep adding similar properties to your portflolio, you never pay back the depreciation. Over a long period of time with property appreciation the amount becomes negligible if you do sell.Also, as I've mentioned a few times in other posts;
you can actually buy a property that is initially neg geared, but after tax return and depreciation (on-paper deductions) are added, the property is cashflow positive after tax.Not many people understand this concept. They confuse it with positive gearing. The difference is that with positive gearing your rent covers all outgoings and there is a positive cashflow. This is then taxed like a normal business profit.
Pos cashflow after tax means you get better cashflow through the tax return, no tax is payable and the property costs you nothing from your own pocket. You can also arrange to have your tax return paid back to you each week instead of waiting all year to receive it if you wish, thus effectively wiping out any out of pocket expenses.
Combine all this into a property purchased in a cap growth area, and you have a winner.
In regards to a property purchased after may 1997 the following happens in regards to depreciation on plant and equipment and capital works (building)
When you sell a property the purchase price is reduced by any depreciable items in it and any capital works deductions you have claimed. For example
Bob buys an off the plan unit for $440,000 in 1998and it has plant and equipment of $40,000 and capital works of $120,000. In 2008 he sells it for $880,000. The plant and equipment is now worth $10000 and the capital works claimed are $30,000
Cost Base is $440,000 less $40,000 P & E less $30,000 capital works plus incidentals of purchase $20000 equals $390,000
Sale Price is $880,000 less $10000 less incidentals of sale $10000 equals $860,000
Capital gain is $860,000 less 390,000 equals $470,000
Discount gain is 50% so the taxable capital gain drops to $230,000Thats how a capital gain is determined and thats how capital works and plant and equipment operate and are treated in a capital gain
Hello Jeff
Looking at your example is it then correct to say that there is no advantage to supplying a depreciation schedule showing the written down vaue of both P&E and capital works with the contract of sale? Or have I totally missed it?
Thanks
ElkaYeah you have missed the point
I was just demonstrating how capital gains and depreciation work when your property is sold if it was bought after 13 may 1997.
You get the tax deduction initially which is good however these very deductions claimed then later on adjust the capital gain you have
I have never had any of my clients supply a deprecation schedule on any of the properties they sell
Its not common in townsville from my experience
jeffIt doesn't happen anywhere, except with commercial property.
Of course, there is an obligation on the part of vendors to provide construction costs if they know them, but few do.
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