Capital works: demolition expenditure and deduction for destruction

Can demolition costs increase the amount of deduction allowable under section 43-40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. Demolition costs can increase the amount of deduction allowable under section 43-40 of the ITAA 1997, to the extent that these costs reduce the amounts received for disposing of the destroyed capital works, as set out in paragraph 43-255 (b) of the ITAA 1997.

The taxpayer was previously entitled to deduct an amount under Division 43 of the ITAA 1997 for a building that it owned. The taxpayer voluntarily demolished the building and was entitled to a deduction under section 43-40 of the ITAA 1997 for the destruction of capital works. The taxpayer incurred $5,000 demolition costs. The undeducted construction expenditure for the building at the date of its destruction was $50,000.

Section 43-40 of the ITAA 1997 allows a taxpayer to immediately deduct, in the income year in which the capital works was destroyed, the amount of construction expenditure that has not yet been deducted, provided the conditions in section 43-40 are met.

Expenditure on demolishing existing structures is not an amount that can contribute to a deduction for capital works under section 43-10 of the ITAA 1997. This is because it is not construction expenditure (paragraph 43-70(2)(b) of the ITAA 1997). However, such expenditure is taken into account in calculating a deduction under section 43-40 of the ITAA 1997.

The amount deductible under section 43-40 of the ITAA 1997 is calculated using the method statement set out in section 43-250 of the ITAA 1997. Step 1 in section 43-250 provides that the balancing deduction amount is the undeducted construction expenditure for the destroyed capital works that exceeds the amounts you have received, or have a right to receive, for the destruction of the capital works.

Section 43-255 of the ITAA 1997 provides that the amounts you have received or have a right to receive for the destruction of the capital works include: (a) an amount received under an insurance policy or otherwise for the destruction of the capital works, and (b) an amount received for disposing of any property salvaged from the demolition, less any demolition expenditure incurred on the property.

Thus, in calculating the balancing deduction under section 43-250 of the ITAA 1997, demolition expenditure acts to offset the lessening of deduction that occurs because of the fact that an amount has been received for disposing of the destroyed capital works.

The following examples illustrate the operation of sections 43-250 and 43-255 of the ITAA 1997 where different amounts are received for disposing of destroyed capital works. Step 2 in section 43-250 of the ITAA 1997 does not apply.

The taxpayer did not receive any amount for the destruction of the building, but did receive $6,000 salvage receipts for disposing of the destroyed building. The reduction amount calculated as being received for the destruction under section 43-255 of the ITAA 1997 is $1,000. This amount is calculated under paragraph 43-255(b) of the ITAA 1997 as the $6,000 received for disposing of the property less the $5,000 demolition costs.

The balancing amount under section 43-250 of the ITAA 1997 is $49,000 ($50,000-$1,000).

The taxpayer did not receive any amount for the destruction of the building, but did receive $4,000 salvage receipts for disposing of the destroyed building. The reduction amount calculated as being received for the destruction under section 43-255 of the ITAA 1997 is zero. This amount is calculated under paragraph 43-255(b) of the ITAA 1997 by reducing the $4,000 received amount to zero by the demolition expenditure of $5,000. The $1,000 excess of demolition expenditure over the amount received for disposing of the destroyed building is not deductible under Division 43 of the ITAA 1997.

The balancing deduction amount under section 43-250 of the ITAA 1997 is $50,000 ($50,000-$0).

There may be capital gains tax implications under Part 3-1 of the ITAA 1997 for the balance of the demolition expenditure incurred that is not taken into account in calculating the balancing deduction under section 43-250 of the ITAA 1997 (in this example, $1,000).

The taxpayer did not receive any amount for the destruction of the building, and did not receive any amounts for disposing of the destroyed building. The reduction amount calculated as being received for the destruction under section 43-255 of the ITAA 1997 is zero. The $5,000 excess of demolition expenditure over the amount received for disposing of the destroyed building is not deductible under Division 43 of the ITAA 1997.

The balancing deduction under section 43-250 of the ITAA 1997 is $50,000 ($50,000 - $0).

There may be capital gains tax implications under Part 3-1 of the ITAA 1997 for the balance of the demolition expenditure incurred (in this example, $5,000).

The taxpayer received an amount under an insurance policy of $1,000 for the destruction of the building and salvage receipts of $1,000 for disposing of the destroyed building. The amount received under paragraph 43-255(a) of the ITAA 1997 is $1,000. The amount received under paragraph 43-255(b) of the ITAA 1997 is zero. This latter amount is the $1,000 salvage receipts reduced by the $5,000 demolition expenditure amount. The $4,000 excess of demolition expenditure over the amount received for disposing of the destroyed building is not deductible under Division 43 of the ITAA 1997. The sum of the amounts in paragraphs 43-255(a) and (b) is $1,000.

The balancing deduction under section 43-250 of the ITAA 1997 is 49,000 ($50,000 - $1,000).

There may be capital gains tax implications under Part 3-1 of the ITAA 1997 for the balance of the demolition expenditure incurred (in this example, $4,000).