How depreciation affects capital gains tax

In this Real Estate Talk show we answered a question from one of our listeners on depreciation and capital gains tax.

We asked Brad Beer from BMT Quantity Surveyors for his thoughts.

Here’s the transcript:

Kevin:  I had a question sent in from Gary.

I have an investment property that I claim depreciation on each tax year.

Can you please advise what happens when I sell the property? Do I then have to pay back everything that I’ve claimed? Does this mean all of the deductions have to be paid back?

For example, if I get $5000 worth of depreciation and I’m on a 30% tax bracket, I get approximately $1500 back. Do I only have to factor in the $1500 or the full $5000? How does it work?

Well, Gary, let’s get an answer on that question for you from Brad Beer from BMT Tax Depreciation. 

Can you answer Gary’s question?

Brad:  Look, I can. I’ll explain how depreciation affects capital gains tax.

Brad-Beer_avatar_1400740647

This is a very regular question I get. We’re the quantity surveyor that works out the depreciation.

We don’t do the rest of your tax return, but I kind of know how it works.

When you claim depreciation what happens is and in this example, he’s saying:

“If I claim $5000 worth of depreciations, I get that back at my tax rate at 30% at $1500.”

Now, if or when you actually sell a property, what happens is that that $5000 actually gets added to your cost base for the purpose of capital gains tax.

What’s going to happen is you’re going to pay more capital gains tax based on what you claimed.

However, usually, under the current rules, what happens is you get a 50% exemption on that capital gains tax payable, providing you’ve owned it for 12 months or more.

What that means is that in this scenario, there’s $5000 additional income added to the end value from a cost base perspective, and you’ll pay additional capital gains tax at half of that marginal rate.

In this scenario, he’ll pay back $750 of his $1500 effectively on the sale of the property.

Kevin:  There’s still a net benefit, though, isn’t there?

Brad:  Yes. The fact is he’s made a deduction, he’s got $1500 in the pocket, and then if he sells the property, for that year, he’s going to pay $750 of it back to the tax office.

Now, that’s only half of it.

The other thing is also about the time value of money. coin house money tax

There are different tax brackets and things like that, but what happens is in most scenarios, because you’re only paying that tax at half the amount, it pretty much always works out that it’s worth actually claiming it on the way through, and then at the end, when you pay some additional capital gains tax, you’ve put more money in your pocket on the way through.

If I get a dollar in my pocket today, it’s worth more than a dollar in my pocket in a year or two years or three years’ time.

Capital gains tax is something you pay if you sell or when you sell, which will – I assume – be at a later date.

You get to use that money.

You can put it into reduce debt and do things on the way through.

You just need to have some more available at the time when you potentially sell the property.

Kevin:  As always, though, Gary, make sure that you check with your accountant.

Listen to the full show at RealEstateTalk.com.au and while you’re there subscribe and receive our weekly podcast (or the transcripts) where I interview Australia’s leading property experts. 

Related article: Tax Depreciation Schedules 101



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'How depreciation affects capital gains tax' have 4 comments

  1. August 8, 2015 @ 7:11 am Hamish

    Ah the old depreciation claw back. The “expert” on ABC 774 a few Saturday mornings ago had not clue about this simple but important aspect. I think about it like this: depreciation reduces the cost base, so the capital gain is higher on eventual sale.

    Assuming you are holding for the long term, then perhaps you are not planning on selling until you are retired, which means your average tax rate will be lower.

    Better still, acquire the asset in a discretionary trust so the income and capital gain can be distributed appropriately (I am still trying to figure out exactly how that works though – specifically do you need to get equity into the trust as a deposit, and if so, how do you capitalise the trust?)

    Reply

    • August 9, 2015 @ 10:20 am Andrew

      That’s a nasty claw back. I had no idea. So, if I bought a 500k apartment, and claimed 70k over 10 years in depreciation, and then sold it for 600k in 10 years times, I need assume the actual price sold was $670? This means I would need to pay CGT on 170k?

      That is a positive story.

      What happens if the apartment has very bad capital gains, and I sell it to just pay out the mortgage after say 3 years? I will be left with a possible 15k tax debt? ouch.

      Are there any rules to wipe it clean if you make it your primary place of residence?

      Reply

      • August 9, 2015 @ 10:36 am Michael Yardney

        Andrew

        you’re right and many people don’t know of this hidden claw back of depreciation.

        As for your PPR – no capital gains tax , but you can’t claim depreciation either

        Reply

  2. May 1, 2016 @ 8:13 am Luke

    An interesting article that addresses an issue many investors are not aware of.
    One thing I did find a little confusing in Brads article is that he states a $5000 depreciation claim is added to your cost base. Won’t adding $5000 to the costs actually reduce the capital gain and therefore reduce Capital gains tax. Maybe stating a depreciation claim of $5000 reduces the cost base by $5000 would make more sense to the readers. I was only able to make sense of this statement after reading comments by Andrew and Hamish. Cheers, Luke

    Reply


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