Private ruling: Rental property destroyed by a disaster
Date of advice: 22 January 2016
Published: March 2016
Ruling period: Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Is there a CGT event triggered due to the disaster? | A1: Yes. | Q2: Are the demolishing costs deductable as a rental loss? | A2: No. | Q3: Are the demolishing costs deductable against the insurance payout? | A3: No. | Q4: Is there any rollover relief available to taxpayer for the income year 20XX if capital expenditure in repairing, restoring or replacing the original asset is incurred no later than the end of the 20XX-XX financial year? | A4: Yes.

Relevant facts and circumstances: You own a rental property. The property is a post CGT asset and was first rented in 19XX. The property was damaged due to disaster and you received an insurance payout in 20XX to rebuild the dwelling. You have incurred demolition costs to demolish the damaged property. These costs were not covered by your insurance. You intend to rebuild the property. It is a large project and you don't have experience with the building industry; as such you expect it would take around 12 months to complete. You incurred no expenditure of a capital nature in repairing or restoring the property earlier than one year before the event. You anticipate the cost to rebuild the property would be more than the insurance payout received.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1, | Income Tax Assessment Act 1997 division 43, | Income Tax Assessment Act 1997 section 43-10, | Income Tax Assessment Act 1997 section 43-40, | Income Tax Assessment Act 1997 paragraph 43-70(2)(b), | Income Tax Assessment Act 1997 section 43-250, | Income Tax Assessment Act 1997 section 43-250, | Income Tax Assessment Act 1997 subsection 104-20(1), | Income Tax Assessment Act 1997 subsection 104-20(2), | Income Tax Assessment Act 1997 subdivision 124-B, | Income Tax Assessment Act 1997 section 124-75, | Income Tax Assessment Act 1997 subsection 124-75(3) and | Income Tax Assessment Act 1997 section 124-85.

Reasons for decision: Summary: Subsection 104-20(1) of the Income Tax Assessment Act 1997 states that CGT event C1 happens if a CGT asset you own is lost or destroyed. Subsection 104-20(2) of the ITAA 1997 states that the time of the event is: (a) when you first receive compensation for the loss or destruction; or (b) if you receive no compensation - when the loss is discovered or the destruction occurred. You make a capital gain if the capital proceeds from the loss or destruction are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base. | Detailed Reasoning - In your circumstances: Your property was destroyed by a disaster and you received compensation for the destruction of your asset. The time when you received compensation is the time of the CGT event according to capital gains provisions. | Detailed Reasoning - Allowable deductions: Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income. | Detailed Reasoning - Repairs: In addition; section 25-10 of the ITAA 1997 allows a deduction for the cost of repairs to premises used for income producing purposes, to the extent that the expenditure is not capital in nature. Taxation Ruling TR 97/23 explains the circumstances in which deductions for repairs are allowable. TR 97/23 states that what is a repair for the purposes of section 25-10 of the ITAA 1997 is a question of fact and degree in each case having regard to the appearance, form, state and condition of the particular property at the time the expenditure is incurred and to the nature and extent of the work done to the property. The ruling further states that repairs mean the remedying or making good of defects in, damage to, or deterioration of, property. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated. | Detailed Reasoning - Capital: Taxation Ruling IT 2197 provides the Commissioners view on demolition costs. Paragraph 7 states that costs incurred in the demolition of plant and the general clearing of a site for the installation or erection of new plant and equipment is or a capital nature and no income tax deduction will be allowable. | Detailed Reasoning - Application to your circumstances: Costs you incurred for demolition are capital in nature, they do not meet the requirements of section 25-10 of the ITAA 1997 and you cannot claim an immediate deduction under section 8-1 of the ITAA 1997. | Detailed Reasoning - Question 3: ATO ID 2003/833 provides the Commissioners view on demolition expenditure and deductions for destruction of capital works. Section 43-40 of the ITAA 1997 allows a taxpayer to immediately deduct, in the income year in which the capital works was destroyed, the amount of construction expenditure that has not yet been deducted, provided the conditions in section 43-40 are met: (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 an amount of undeducted construction expenditure for your area; and (c) you were using your area in the way that applies 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. 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. This is because it is not construction expenditure (paragraph 43-70(2)(b) of the ITAA 1997). However, such expenditure is taken into account in calculating a deduction under section 43-40 of the ITAA 1997. The amount deductible under section 43-40 of the ITAA 1997 is calculated using the method statement set out in section 43-250 of the ITAA 1997. Step 1 in section 43-250 provides that the balancing deduction amount is the undeducted construction expenditure for the destroyed capital works that exceeds the amounts you have received, or have a right to receive, for the destruction of the capital works. 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. 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: (a) an amount received under an insurance policy or otherwise for the destruction of the capital works, and (b) an amount received for disposing of any property salvaged from the demolition, less any demolition expenditure incurred on the property. Example 3 of ATO ID 2003/833 provides a scenario similar to your circumstances: "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 for the destruction 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 this example, $5,000)." | Detailed Reasoning - Application to your circumstances: You received an insurance payout to rebuild your property and did not receive any amount for the demolition of the damaged property. An amount incurred in demolition expenses in excess to the amount received for disposing of a destroyed asset is not deductible under division 43 of the ITAA 1997. | Detailed Reasoning - Question 4: Subdivision 124-B of the ITAA 1997 provides you with the opportunity to choose rollover relief where a CGT asset you own, or part of it, is lost or destroyed. Section 124-75 of the ITAA 1997 allows you to choose to obtain a roll-over if you receive money for the event occurring and you satisfy the following requirements. You must incur expenditure (a) acquiring a replacement asset, or (b) if only part of the asset is lost or destroyed, you incur expenditure of a capital nature repairing or restoring it. To qualify for the roll-over at least some of the expenditure must be incurred: (a) no earlier than one year before the event happens; or (b) no later than one year after the end of the income year in which the event happens; (c) or within such further time as the Commissioner allows in special circumstances. If you receive money as a result of the compulsory acquisition, you can only choose a rollover if you incur expenditure in acquiring another CGT asset. Under subsection 124-75(3), you must incur at least some of the expenditure no earlier than one year before the event happens or, within one year after the end of the income year in which the event happens. Section 124-85 of the ITAA 1997 provides the consequences if you receive money and choose to obtain a roll-over. If the money received does not exceed the expenditure to acquire another CGT asset or to repair or restore the original asset; the gain is disregarded. The gain is disregarded in working out your net capital gain or net capital loss for the income year. The amount of expenditure that you can include in the cost base of the replacement asset is reduced by the amount of the capital gain. | Detailed Reasoning - Application to your circumstances: A rollover is available for you to choose under subdivision 124-B of the ITAA 1997. In order to choose the rollover you must incur capital expenditure no later than one year after the end of the income year in which the event happened. In your case the CGT event occurs when you received the insurance payout in late 20XX. You have until the end of the 20XX-XX financial year to incur capital expenditure acquiring a replacement asset or within such further time as the Commissioner allows in special circumstances. You anticipate the costs of building the property to be greater than the insurance payout you received. If the amount of money you received is less than or equal to the expenditure you incurred to repair or replace the original asset, you disregard any capital gain. You reduce the expenditure you include in the cost base of the asset when a later CGT event happens by the amount of the gain.