When a property is declared a total loss due to an unforeseen event, understanding how depreciation interacts with your insurance claim can be complex. In Australia, depreciation on a property ceases when the asset is no longer used or available for use. This is the case when the property is deemed a total loss and is no longer capable of generating income.
Under Division 40 of ITAA 1997, depreciation is applicable to plant and equipment assets that are used or installed ready for use in generating assessable income. However, when a property is destroyed or rendered unusable, these assets are neither used nor available for use, thus depreciation claims must stop. The most common misconception is that investors can continue to claim depreciation until the insurance payout is received, but this is incorrect.
To see how this plays out, consider a 2015-built three-bedroom house in Perth valued at $700,000. The house suffers significant damage from a natural disaster and is declared a total loss. The owner receives an insurance payout of $650,000. Because the property is no longer available for use, any plant and equipment depreciation claims cease immediately from the date of loss. If the owner was previously claiming $5,000 annually in depreciation on plant and equipment, this potential deduction is lost.
In our experience reviewing thousands of properties across Australia, several patterns emerge. Many investors are unaware that depreciation stops immediately upon a total loss, leading to incorrect tax returns. Additionally, some fail to adjust their capital gains tax calculations post-loss, potentially costing them more in taxes. We also find that investors often overlook the impact of insurance payouts on their property's cost base, affecting future CGT calculations.
The answer can differ depending on your situation. If the property was acquired before 9 May 2017, different rules may apply to previously used plant and equipment. Similarly, if the property is part of a Self-Managed Super Fund (SMSF), distinct tax implications might arise. Owners of commercial properties might also face different considerations, as commercial insurance policies and depreciation rules can vary significantly from residential ones.
Given the complexities involved, seeking professional advice is crucial. A Chartered Quantity Surveyor can accurately assess the impact on your depreciation schedule, while an accountant can help navigate the tax implications of your insurance payout. This collaboration ensures that you maximise your tax position and avoid costly mistakes.