Mythbuster: Claiming Depreciation will increase Capital Gain Tax implications in the future
Capital Gain Tax (CGT) is a tax on the capital gain/loss of the property. It has been a huge concern for property investor who is looking to sell their investment property in the future, mainly due to huge tax implication on the capital gain of their property.
At the same time, it also hinder the investor to claim on depreciation of their investment property, because any capital work (Division 43) they have claimed when they own the property, it will reduce the cost base of their property, which in turn increase capital gain value of their property.
This much is a true fact, but I am here to tell you that claiming depreciation on your investment property will increase the cash gain you received, even after selling your property.
There are 2 elements of depreciation an investor can claim:
1. Division 43 - Capital work
2. Division 40 - Plant and equipment
Out of 2 elements, only Division 43 - Capital work deductions that you claim will actually reduce cost base of the property.
Let me put it into example:
Without claiming depreciation:
Investor A purchase property A for $500,000 in 2010
At 2015, Investor A sold his property for $700,000 triggering Capital Gain Tax.
Assuming Investor A is being taxed at 37% rate, he has to pay the following capital gain tax:
So after paying Investor A's capital gain tax, Investor A left with $126,000 cash profit from selling his property.
With claiming depreciation:
With the same scenario as above and Investor A also been claiming total depreciation for $10,000 per year for 5 years, which consist of $7000 Division 43 and $3000 Division 40.
Now with claiming depreciation, Investor A is paying more capital gain tax, but after adding back all the cash Investor A gained from claiming depreciation allowance, Investor A ends up with $131,550 profit total, which is $5,550 more cash on hand than without claiming depreciation at all.
What if Investor A entitled to 50% Capital Gain Tax discount:
This calculation works even better assuming Investor A live in the property for 1 year within the 5 years Investor A own the property. This will trigger 50% discount on any capital gain of the property (well it will even trigger 6 year exemption rule, which will exempt Investor A from any CGT, but for the purpose of this example, let's just assume Investor A only entitled to 50% discount by making Property A Principal Place of Residence (PPOR)).
After calculating CGT post-50% discount, Investor A is left with $9,620 more cash on hand with claiming depreciation.
In conclusion, it is obvious that claiming capital works (Division 43) deduction is reducing the cost base of property and increasing Capital Gain Tax, but in the end, the owner will have more cash/profit on hand due to Plant and Equipment (Division 40) that he/she claimed + any discount on CGT will further enhance the benefit of claiming depreciation.
To get more information about CGT and tax depreciation, feel free to contact myself here.