05 Aug How depreciation affects capital gains tax? – Brad Beer
Today, together with Brad Beer from BMT Tax Depreciation, we answer your question!
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?
Kevin: I had a question sent in, which we’re going to answer now, from Gary. Thank you for the question, Gary. I’ll just quickly read through it and then introduce the person who will answer it for you.
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 experts.
Brad, thanks for your time.
Brad: Thanks, Kevin. It’s nice to be here.
Kevin: Can you answer Gary’s question?
Brad: Look, I can. The question relates a bit to his situation. It’s a bit of an accountant whirl, but I’ll give you the how depreciation affects capital gains tax answer really, and in this particular scenario, I can give you pretty close to what it would be, definitely.
Kevin: Fire away.
Brad: Now, it 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.
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.
The other thing is also about the time value of money. 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. I’m sure you would agree with that, Brad. Just check with your accountant. Your individual circumstances may alter that advice.
Kevin: Brad, can I just ask you, at this time of year, any advice that you might have for property investors?
Brad: Well, Kevin, it’s interesting. Over the last few months, there’s been a fair bit of heat in a lot of markets around a lot of the country – not everywhere, but a lot of the country. One thing that makes me think about is just making sure you’re crunching your numbers properly. If prices have moved forward, the cost of owning that property is a little bit higher than it used to be, and really have a good look.
It’s all well to follow what a lot of people are buying and feel like you really need to get into the market right now before they go up too much, but you still have to make the payments, you still have to hold the property over time and make money or wealth out of that property in the future, so make sure you crunch your numbers – depreciation estimates are one part of that – and see what really is going to cost you to hold that property.
Consider that interest rates could go up in the future at some point when you do that, so make sure you do some scenarios both ways to make sure you could still hang onto it so that if it’s not quite so hot, you are still safe.
Kevin: Very good advice from Brad Beer from BMT Tax Depreciation. Brad, thanks again for your time.
Brad: Thanks, Kevin. Appreciate it.