What are Capital Works Deductions?
Capital works deductions are essentially income tax deductions a property owner can claim for the decline in value of a building and other items that are regarded as being fixed to the property. It works in a similar way to the way a business claims depreciation for the decline in value of their plant, vehicles and other fixed assets. As a result, claims can be substantial depending on the value of the structure, it’s age and the nature of the fixtures.
What can I claim?
The deductions for fixtures associated with a commercial property are largely made up of the building itself, or the ‘bricks and mortar’ structure, and apply to buildings constructed after July 1982. However, they can also extend to other fixtures, including carparks, kitchenette and amenities fitouts, built-in workstations, mezzanines, glass partitions and shelving. This is not limited to the initial cost of installing the fixture – it can also include the costs of fixtures installed during renovations performed after the building was constructed, where these improvements were performed after February 1992.
How do I calculate my claim?
Where you haven’t built the building, calculating the cost and amount claimable is best done by a qualified quantity surveyor or independent qualified person. This is important, as there are different deduction rates available depending on the nature of the fixtures and when they were installed/constructed. A quantity surveyor can also assist with calculating an estimated construction cost of buildings and fixtures, which is particularly useful when the property has an existing building that was constructed by a previous owner.
How could it benefit me?
Generally, the biggest benefit to a property owner is the
improved after-tax cash flow on an income-producing property during the period
of ownership. To help highlight the potential cash flow advantages, consider
the below hypothetical scenarios for Andrew and Sasha. Firstly, we’ll assume
that they purchase a property for $1,000,000 and sell this property 5 years
later for $1,600,000 (a gain of $600,000). We’ll also assume that the property
generates $60,000 in rental profits after outgoings each year, and that they
each have a personal income tax rate of 39%.
If Andrew and Sasha decide not to utilise the capital works deduction provisions, they will not require the services of a quantity surveyor. Instead, they will pay income tax based on their $60,000 of rental income, and pay capital gains tax on the capital profit in the year they sell the property. As they have owned the property for more than 12 months at the time of selling, they are eligible to halve the amount of the capital profit they are taxed on. Their circumstances may look something like this:
|
Scenario 1: |
Yr 1 |
Yr 2 |
Yr 3 |
Yr 4 |
Yr 5 |
Total |
|
Rental Profit |
$60,000 |
$60,000 |
$60,000 |
$60,000 |
$60,000 |
$300,000 |
|
Capital Gain |
$600,000 |
$600,000 |
||||
|
Less 50% Capital Gain Concession |
-$300,000 |
-$300,000 |
||||
|
Total Taxable Income |
$60,000 |
$60,000 |
$60,000 |
$60,000 |
$360,000 |
$600,000 |
|
Tax at 39% |
-$23,400 |
-$23,400 |
-$23,400 |
-$23,400 |
-$140,400 |
-$234,000 |
|
After-Tax Income |
$36,600 |
$36,600 |
$36,600 |
$36,600 |
$219,600 |
$366,000 |
|
After-Tax Cash Flow |
$36,600 |
$36,600 |
$36,600 |
$36,600 |
$519,600 |
$666,000 |
Let’s now assume Andrew and Sasha engage a quantity surveyor to calculate their eligible capital works deductions. The quantity surveyor estimates a total construction cost of $600,000 and, using a capital works deduction rate of 2.5% p.a. this allows them to claim a tax deduction of $15,000 per year. While this means the remaining cost base of their property is slightly higher when they come to sell (due to the capital works deductions claimed in years 1-5), their situation would look something like this:
|
Scenario 2: |
Yr 1 |
Yr 2 |
Yr 3 |
Yr 4 |
Yr 5 |
Total |
|
Rental Profit |
$60,000 |
$60,000 |
$60,000 |
$60,000 |
$60,000 |
$300,000 |
|
Less Capital Works Deductions |
-$15,000 |
-$15,000 |
-$15,000 |
-$15,000 |
-$15,000 |
-$75,000 |
|
Capital Gain |
$675,000 |
$675,000 |
||||
|
Less 50% Capital Gain Concession |
-$337,500 |
-$337,500 |
||||
|
Total Taxable Income |
$45,000 |
$45,000 |
$45,000 |
$45,000 |
$382,500 |
$562,500 |
|
Tax at 39% |
-$17,550 |
-$17,550 |
-$17,550 |
-$17,550 |
-$149,175 |
-$219,375 |
|
After-Tax Income |
$27,450 |
$27,450 |
$27,450 |
$27,450 |
$233,325 |
$343,125 |
|
After-Tax Cash Flow |
$42,450 |
$42,450 |
$42,450 |
$42,450 |
$510,825 |
$680,625 |
As a result, Andrew and Sasha have a cash flow improvement of $5,850 each year by utilising the capital works deduction provisions, and are $14,625 better off over the period of ownership.
The scenarios and information provided above are not
financial or specific advice, and independent advice should be sought if you
feel this could be beneficial for your circumstances. UBTA would be happy to
assist you with estimating the tax and cash flow implications, and can put you
in touch with quantity surveyors to assist you in calculating your capital
works deduction if required. Please don’t hesitate to contact your UBTA Account
Manager or call us on 1300 567 819 to discuss further.