The last few months have seen some wild weather causing storm and flood damage in various parts of the country. This has resulted in insurance claims and property owners setting about putting the damage right. Where the damaged property is a business asset, such as a business premises, or is used to derive income, such as a rental property, there are tax considerations in relation to insurance receipts and the repair work being undertaken.
The cost of making good the damage caused by a storm and restoring the property to its pre-storm condition will generally be a tax-deductible expense, commonly referred to as “repairs and maintenance” expenditure. However, in some cases the work necessary to restore an asset may be so extensive that the expenditure loses its deductible nature and becomes non-deductible capital expenditure. Where the remedial work results in the reconstruction, replacement or renewal of the asset, or substantially the whole of the asset, the expenditure will generally be non-deductible capital expenditure.
The key is to identify correctly the asset on which the remedial work is undertaken, so that the extent of the work on that asset can be gauged to determine deductibility. This involves considering whether the item is part of a larger asset or a separate asset in itself.
For example, due to flooding the carpet in a rental property is replaced. Carpet is considered a separate asset from the building; replacing carpet is replacing an asset and its cost is non-deductible capital expenditure. By contrast, replacing flood damaged framing and wall linings in a single room in a building would likely be a deductible repair. The asset is the building and the work is not of sufficient significance in relation to the building for the expenditure to lose its deductible repair nature.
Whether the work is a deductible repair or a non-deductible improvement will influence the treatment of any insurance receipt received to remedy the damage. Any insurance pay-out received in relation to repair work will be income to the extent that the cost of undertaking that repair is deductible. Any surplus over the repair expenditure should be a non-taxable capital receipt. If the work undertaken is of a non-deductible capital nature, then the insurance proceeds should be a non-taxable capital receipt.
Contact your Findex adviser for assistance with the taxation treatment of any repairs you are undertaking or insurance proceeds you have received.