Don’t forget about capital works tax deductions

Business can often forget about claiming capital works deductions for property improvements. Tax expert TERRY HAYES explains how these deductions work.

By Terry Hayes

Business can often forget about claiming capital works deductions for property improvements. Here’s how these deductions work.

The tax law allows the cost of constructing “capital works” to be written off. The write-off applies to buildings, structural improvements and environmental protection earthworks; and extensions, alterations and improvements to these.

Basically most works done in respect of income-producing buildings – that is, to qualify for the deduction, the building must be used for the production of assessable income.

While this may sound like depreciation, it is not. It gets a little technical, but the tax law allows annual deductions/write-offs of a set percentage of qualifying expenditure.

Businesses can forget about claiming these capital works deductions, so it’s a good idea to have some understanding of how the deductions work. It is easy to make mistakes with these deductions, so always check with your tax adviser or accountant.

Rates of deduction

Different deduction rates apply depending upon the date of commencement of construction and the type of structure.

For example, capital expenditure incurred after 21 August 1979 on traveller accommodation is deductible at the rate of 2.5% a year.

Where construction of the relevant building commenced after 21 August 1984, the rate of deduction is 4% for both traveller accommodation and buildings used for producing assessable income. This deduction extended to all income-producing buildings, including those used for residential purposes where construction commenced after 17 July 1985.

The only exclusion is property used for exhibition or display in connection with the sale of that building or any other building.

Where construction commenced after 15 September 1987, the deduction was reduced to 2.5% of the cost of the building. Buildings that qualified for the 4% deduction continued to enjoy that rate of deduction. The 2.5% deduction was extended to buildings used for R&D activities where construction commenced on or after 21 November 1987.

The tax office notes that capital works deductions for structural improvements can only be claimed for construction that started after 26 February 1992, and are claimed over 40 years at 2.5% a year. For the purpose of the deduction, the tax law treats certain structural improvements as if they were buildings – sealed roads, carparks, pipelines, retaining walls, fences.

Where construction commenced on or after 27 February 1992, the deduction is calculated as follows:

Relevant structures include:

• Hotel buildings and apartment buildings used for short-term traveller accommodation;
• Industrial buildings – manufacturing, timber milling, printing;
• Research and development facilities;
• Income-producing structural improvements;
• Environmental protection buildings and earthworks.

Capital works deductions can be claimed from the date the construction is complete. It’s just that the date the construction commenced determines the percentage of the deduction (as indicated in the table above).

What costs are deductible?

Construction expenditure forms the basis of the tax deduction. This includes engineering, drafting and architects’ fees, but does not include costs of acquiring land, cost of demolishing existing structures, or expenditure on clearing or levelling or landscaping.

A deduction is allowed for expenditure incurred if a taxpayer contracts a builder to construct the building on their land. This includes the payment component representing the profit made by individual tradespeople, builders and architects. However, if taxpayers purchase a property from a speculative builder, they cannot claim for the builder’s profit margin.

If the construction expenditure of a building cannot be precisely determined, the tax office says an estimate provided by an appropriately qualified person can be used. An appropriately qualified person can include:

• A clerk of works, such as a project organiser for major building projects;
• A supervising architect who approves payments at project stages;
• A builder experienced in estimating construction costs of similar building projects;
• A quantity surveyor.

It should be noted that the tax office considers that valuers, real estate agents, accountants and solicitors will generally have neither the relevant qualifications nor the experience to make such an estimate, unless they have other appropriate qualifications.

As I said at the outset, these deductions get somewhat complicated, but they are valuable and should not be overlooked. If an SME owner thinks he or she might be able to claim them, then talk to your accountant about it.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.

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