Tax impact of Buying or Selling Second-hand Depreciating Assets
Buying or selling second hand assets can cause headaches at tax time. TLK Partners’ property acquisitionspecialist, Mr Matthew Mousa, offers insight into how to handle these situations, and what effect they have on tax obligations.
Matthew compares dealing with tax deduction claims on long-life assets to finding one’s way through a labyrinth, even when dealing with new items that will help generate rental income. Yet getting through this maze can become even more complicated, he says, when other factors become involved, like the disposal of a depreciating asset.
Basically, a depreciating asset is one which has a long projected lifespan as an effective asset in generating income. Deductions against income, originally based on the asset’s initial cost, are spread over a period of years on a sliding scale schedule. This scale takes into account the asset’s dropping value and shortening lifespan as an income generator.
When an asset like this can’t (or won’t ever again) be used to facilitate rental income, its tax position as a depreciating asset changes immediately. “Because it is no longer involved in generating an income, it doesn’t count as a deduction on your future tax returns, and therefore stops playing any part in determining future taxes,” Matthew explains. But it can’t just disappear off a return before the books on its tax history, including any remaining depreciation value, have been balanced and closed.
There are various ways in which an item like this could have been “disposed” of. The most obvious is that it has been sold, lost or destroyed. A homeowner may have planned to use the asset to generate rental income, and then decided against it; cancelled its installation; or changed the way he uses it, so its sole purpose is no longer generating a rental income. An asset may also have to be “disposed of” if it was considered while in a partnership, but the use of the asset, or the nature of the partnership, has changed since then.
“All these reasons are valid ones for its disposal in terms of tax. The bottom-line is that you must be able to affirm that you do not expect to ever use it again for its original purpose,” Matthew says.
To change the asset’s status somewhere down the line, when the depreciation process has not been completed, requires levelling the scales on what’s gone out and what’s come in with regard to that asset’s disposal. This involves creating a “balancing adjustment event” on a tax return. To do this, the following steps need to be taken:
Work out what value of the depreciating asset remains unclaimed. This becomes the balancing adjustment value.
Then take selling price of the depreciating asset, or termination value if it was scrapped, and compare it with the adjustable value.
If the termination value (sale price) of the asset is greater than the adjustable value; the difference between the two becomes a form of income which has to be added to assessable income along with income from other sources, including rent. However, it is not included as part of the rent, but instead listed under “Other Income” on a tax return.
If the adjustable value is greater than the termination value, deduct the difference on the current return.
When purchasing a second-hand asset, its price can generally be claimed, in the same way as the cost of a new asset would be claimed for, and subject to the same conditions regarding its projected life-span and purchase price as are applied to new assets.
However, if second-hand assets form part of package when a rental property is bought, there are some steps that need to be taken to separate them from the rest of the package.
The depreciating assets that come with the rental property must be separated from the price of the property itself based on reasonable values determined by both seller and buyer, and specified as part of the sale agreement.
If they aren’t specified, a reasonable cost will have to be determined by the homeowner. If unable to do so, a qualified evaluator will have to be called in. Whichever way it’s done, the owner must be able to show a firm basis for establishing the value.
“Sound taxation advice and planning can save heartache and financial surprises,” Matthew concludes.
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