Private ruling: Rental deduction – demolition expenses
Date of advice: 5 April 2019
Published: May 2019
Ruling period: Year ended 30 June 2019
Date scheme commenced: 1 July 2018

Ruling: Q1: Are you able to immediately deduct under Division 43 of the Income Tax Assessment Act 1997 (ITAA 1997) undeducted amounts of capital expenditure after voluntarily demolishing your rental property? | A1: Yes. | Q2: Are you able to immediately deduct under Division 40 of the ITAA 1997 undeducted amounts of depreciation after voluntarily demolishing your rental property? | A2: Yes. | Q3: Are you able to deduct from your assessable income the amounts incurred for the voluntary demolition of your rental property? | A3: No.

Relevant facts and circumstances: You acquired the property on XX October 20XX for the purpose of producing assessable income. After the purchase of the property, you obtained a quantity surveyor’s depreciation report which provided a valuation and the deductable building allowance and depreciation on chattels. The property has been rented from XX October 20XX until XX January 20XX. On XX January 20XX you signed a contract to have the dwelling on the property demolished. Your tenants vacated the property on XX January 20XX. You handed the property to the demolition contractors on XX February 20XX. Demolition of the property commenced on XX March 20XX (the date of demolition) and was completed on XX March 20XX. The X week period between the tenant vacating the property and demolition commencing, neither you nor any other party used the property for any other purpose. You did not receive an amount for the salvage of the depreciating assets contained with the property at the date of destruction. You entered into a contract for the construction of a new dwelling on XX December 20XX. Construction of the new dwelling commenced after the demolition with the slab being laid on XX March 20XX. You intend to move into the new dwelling as your main residence once construction is completed.

Relevant legislative provisions: Income Tax Assessment Act 1997 subdivision 40-D | Income Tax Assessment Act 1997 section 40-25 | Income Tax Assessment Act 1997 subsection 40-300(2) | Income Tax Assessment Act 1997 subsection 40-285(2) | Income Tax Assessment Act 1997 section 43-40 | Income Tax Assessment Act 1997 subdivision 43-H | Income Tax Assessment Act 1997 section 43-250 | Income Tax Assessment Act 1997 subsection 43-255(b)

Reasons for decision: Detailed Reasoning - Detailed reasoning: Taxation Ruling TR 97/25 discusses deductions for capital expenditure on construction of income producing capital works, including buildings and structural improvements. Paragraph 18 states that the Commissioner considers that section 43-40 of the ITAA 1997 applies both to voluntary and involuntary destruction of capital works. Subsection 43-40(1) of the ITAA 1997 states you can deduct an amount if all or a part of your area is destroyed in an income year and: (a) you have been allowed, or can claim, a deduction under this Division, or former Division 10C or 10D of Part III of the Income Tax Assessment Act 1936 , for your area; and (b) there is amount of un-deducted construction expenditure for your area; and (c) you were using your area in the way that applied to it under Table 43-140 (Current year use) immediately before the destruction or if not, neither you nor any other entity used your area for any purpose since it was last used by you in that way. You have deducted construction expenditure and there are amounts that have not yet been deducted for construction expenditure. As the requirements of paragraphs 43-40(1)(a) and (b) of the ITAA 1997 have been satisfied the issue to be considered is whether paragraph 43-40(1)(c) of the ITAA 1997 has been satisfied. Paragraph 43-40(1)(c) of the ITAA 1997 has two limbs. The first limb is satisfied if ‘your area’ was used immediately before the destruction in a way that applies to it under the table in section 43-140 of the ITAA 1997. The required use for a house constructed in time period three of the table is that the area is used for the purpose of producing assessable income. If it has not been used for this purpose, then the second limb allows a deduction if no entity has used the area for any purpose since it was last used by the taxpayer for the purpose of producing assessable income. In considering if the requirements of paragraph 43-40(1)(c) of the ITAA 1997 are satisfied the meaning of 'immediately before the destruction' must be considered. It has been interpreted by the courts and the Commissioner applied this view in ATO Interpretive Decision 2010/35 (ATO ID 2010/35). The Commissioner’s view is that ‘immediately before’ refers to a relatively short period of time between the last use of the area and its destruction. In your circumstances, you made the decision to demolish the property on XX January 20XX. The tenants vacated the property on XX January 20XX and the demolition began on XX March 20XX. Therefore, the property was not used for the purpose of producing assessable income for the period XX January 20XX to XX March 20XX, which we consider as a relatively short period of time. For the X weeks between the tenant moving out and demolition commencing on the property, neither you nor any other party used the property for any purpose. Therefore, a deduction under subsection 43-40(1) of the ITAA 1997 is allowed for the construction expenditure that has not yet been deducted. | Detailed Reasoning - Detailed Reasoning: Section 40-25 of the ITAA 1997 allows a deduction for the decline in value (depreciation) of a depreciating asset you hold, to the extent the asset is used for a taxable purpose. Subsection 40-25(2) of the ITAA 1997 states that you must reduce your deduction by the part of the assets decline in value that is attributable to your use of the asset, for a purpose other than a taxable purpose. Taxable purpose means for the purpose of producing assessable income. Subdivision 40-D of the ITAA 1997 may allow a balancing adjustment deduction in certain circumstances. Subsection 40-300(2) of the ITAA 1997 contains a table of the termination values of certain balancing adjustment events. Item 8 is where a depreciating asset is lost or destroyed and column three determines that the termination value is the amount or value received or receivable under an insurance policy or otherwise for the loss or destruction. Subsection 40-285(2) of the ITAA 1997 provides that you can deduct an amount if: (a) a balancing adjustment event occurs for a depreciating asset you held and: (i) whose decline in value you worked out under Subdivision 40-B; or (ii) whose decline in value you would have worked out under that Subdivision if you had used the asset; and (b) the asset’s termination value is less than its adjustable value just before the event occurred. The amount you can deduct is the difference between those amounts, and you can deduct it for the income year in which the balancing adjustment event occurs. In your circumstances, the depreciating assets that were contained within the property at the date of destruction were lost or destroyed. You did not receive an amount from the demolition company for the salvage of the depreciating assets within the property. Therefore, the amount you received for the depreciating assets is less than the opening adjustable value of the depreciating assets, subsection 40-285(2) of the ITAA 1997 will apply, and you can deduct the undeducted expenditure from the depreciating assets that were destroyed during the demolition. | Detailed Reasoning - Detailed Reasoning: Expenditure on demolishing existing structures is not an amount that can contribute to a deduction for capital works under section 43-10 of the ITAA 1997 as it is not construction expenditure (paragraph 43-70(2)(b) of the ITAA 1997). However, such expenditure may be taken into account in calculating a deduction under section 43-40 of the ITAA 1997. The amount a taxpayer is entitled to deduct under section 43-40 of the ITAA is determined using the method statement contained in section 43-250 of the ITAA 1997. Under this method statement you are required to reduce your deduction where you have received or have a right to receive amounts for the destruction of the capital works Section 43-255 of the ITAA 1997 provides that the amounts you have received or have a right to receive for the destruction of the capital works include: ● an amount received under an insurance policy or otherwise for the destruction of the capital works, and ● an amount received for disposing of any property salvaged from the demolition, less any demolition expenditure incurred on the property. Thus, in calculating the balancing deduction under section 43-250 of the ITAA 1997, demolition expenditure acts to offset the lessening of deduction that occurs because of the fact that an amount has been received for disposing of the destroyed capital works. ATO Interpretive Decision 2003/833 considers an example where a taxpayer has $50,000 undeducted construction expenditure for a building, they incurred $5,000 in demolition costs and did not receive an amount for the destruction of capital works: | Detailed Reasoning - Example 3: The taxpayer did not receive any amount for the destruction of the building, and did not receive any amounts for disposing of the destroyed building. The reduction amount calculated as being received under section 43-255 of the ITAA 1997 is zero. The $5,000 excess of demolition expenditure over the amount received for disposing of the destroyed building is not deductible under Division 43 of the ITAA 1997. The balancing deduction under section 43-250 of the ITAA 1997 is $50,000 ($50,000 - $0). There may be capital gains tax implications under Part 3-1 of the ITAA 1997 for the balance of the demolition expenditure incurred (in the example, $5,000). In your case, you are not entitled to a deduction for the demolition expenses you incurred; as you received no amounts for the destruction of the capital works the demolition expenses will not act to increase the deduction available to you under section 43-40 of the ITAA 1997.