Who Gets To Depreciate Farm Improvements?

Question

We purchased a 40 ha (100 acre) property in early 2018 for about $920 K, the offer of acceptance included a GST Annexture where the choice “Sale of Farming Business as a Going Concern”, was signed by all parties such that the transaction was GST free. The property was bought in our own names, and we registered a business name in June 2018 under the family trust structure that is also used for our consulting business since 2001.

The farming business will be cattle breeding and hay cutting. We have sold $3000 worth of hay in May (yet to be paid for), and will drop our first calves early next year from 25 young Angus heifers that we have had here for 15 months.

The property was run down and as a result we have spent about $120 K with about 50% on house renovations and 50% on farming infrastructure and costs. Monies provided from our personal accounts.

The question is; can we offset or claim these costs or part of, against earnings from the other business in the trust?

From our reading, as the real property purchase price is above $500 K it appears that we are able to claim these farm setup costs. As per usual your insight and advise would be most appreciated.


Answer

For that clause to apply in the contract, the buyer needs to be registered for GST.  So I am going to assume you and your partner are in a partnership that is registered for GST.  And further assume that the trust is registered for GST.

I will just re-frame your question here to make sure I understand.

You have a partnership with you and your partner that owns the farm and charges rent to the trust to allow it to run a primary production business on the property and run a consulting business.  So we have a partnership of individuals that earn rent income, and a trust that has two sources of income, one running at a loss and the other, the consulting, making a profit.

The partnership/you – spent $60,000 on improving the portion of its property that is used to produce income and as individual owners of the family home that is covered by your main residence exemption you spend $60,000 on renovations.

First question – How and who gets to claim a deduction for the money spent that does not relate to the private use of the property

We need to look at the owners of the property and the trust/tenant separately.  Generally if you, as the owner of the property, undertake an improvement at your expense then, you are entitled to the depreciation. This is the case even if you provide a fit out as an incentive for a tenant to sign a lease ie it is just for the tenant’s (in this case the trust) benefit and doesn’t improve the value of the property.  As long as you retain ownership of the improvement you can depreciate it.

When the tenant pays for the improvement then they are entitled to depreciation if they retain ownership of the improvement.  The problem is if the improvement is fixed or structural it may become your property which means you are entitled to the depreciation claim against the rent instead.   In the case of a fixture to the property, the tenant to have the ownership rights and therefore a right to claim depreciation, the lease must provide the tenant with a right to compensation (that is not nominal) or there must be a method of removing the improvement  There are also various laws in the different states that give tenants  rights to improvements they make to leasehold property.

Non fixed items and plant and equipment, paid for by the tenant, are straight forward because the tenant continues to own them so the tenant gets to claim the depreciation.

Non fixed items and plant and equipment, paid for by the owner/landlord are depreciated by the owner/landlord because they continue to own them even if the tenant is using them.

Having said all that there are special concessions with primary production that allow the tenant to depreciate fencing and other things that you would normally consider a fixture to the land.  More about that here https://www.ato.gov.au/Forms/Guide-to-depreciating-assets-2019/?page=16

A bit of further reading

For CGT consequences read TD 98/23 https://www.ato.gov.au/law/view/document?docid=TXD/TD9823/NAT/ATO/00001

For ATO discussion on who owns what read IT 175 https://www.ato.gov.au/law/view/document?LocID=%22ITR%2FIT175%2FNAT%2FATO%22&PiT=99991231235958  but note that the example excludes primary production.  I am not sure if some of the improvements are for the consultancy business.

As for primary production it takes the ownership of assets attached to the land much further in favour of the lessee ie fences can be depreciated by the lessee https://www.ato.gov.au/Forms/Guide-to-depreciating-assets-2019/?page=16

The last pages of this ATO booklet https://www.ato.gov.au/uploadedFiles/Content/IND/downloads/Rental-properties-2019.pdf   will help you differentiate between structural improvements (Div 43) which are depreciated over 40 years and plant and equipment (Div 40) which has a much quicker rate of depreciation.  Note repairs that take the property to a better condition than what it was when you bought it are improvements so it is very likely all the work you have done will be depreciated.  Bonified repairs can be immediately claimed by either tenant/trust or yourselves depending on who paid for them.

The $500,000 real property threshold applies to div 35 (here is a link to our booklet on that https://www.bantacs.com.au/booklets/Division_35_Offsetting_Business_Losses_Booklet.pdf)  it only applies to individuals offsetting business losses against their personal income.  In your case it is either the trust making the loss and offsetting it against the consulting business or you renting the property at a loss to the trust, which is passive not business income.  In short Div 35 and the $500,000 real property test does not apply.  What may well apply is the personal services income rules.  Here is a link to our booklet on that https://www.bantacs.com.au/booklets/Alienation_Of_Personal_Services_Income.pdf  Note it is not just about passing the 80/20 rule but also making sure the income is earned by either sale of goods or by selling the services of more than just yourself.  The PSI rules will force your personal services income out of the trust and into your personal tax returns before it is offset against the primary production losses.  Also note that you cannot negatively gear the leasing of the farm to the trust if you are not charging market rent.

As you can see this issue needs a conversation to narrow down your options, but the above will give you some ideas.  Please consult with your Accountant before you act.