What is CGT event K7?

CGT event K7 broadly involves a situation where a balancing adjustment event occurs for a depreciating asset held by a taxpayer that was at some time used (or installed ready for use) for a non-taxable purpose, or a purpose contemplated under section 40-27(2)(a) and (b). Those paragraphs in section 40-27 operate to prevent a taxpayer (in certain circumstances) from obtaining deductions for the decline in value of second-hand depreciating assets in residential investment properties.

CGT event K7 can also happen for R&D (research & development) entities in respect of depreciating assets used for a purpose other than conducting R&D activities or for a purpose which is non-taxable.

The rules dealing with CGT event K7 are contained in section 104-235, 104-240 and 104-245 of the Income Tax Assessment Act 1997 (Cth).

CGT event K7 occurs at the time the balancing adjustment event occurs.

How to calculate CGT Event K7 capital gain or loss

The taxpayer makes a capital gain if the termination value of the depreciating asset is more than its cost.

 (Termination value – Cost) x Sum of reductions/Total decline

The taxpayer makes a capital loss if the cost of the depreciating asset is more than its termination value. The amount of the capital loss is calculated using the following formula:

 (Cost – Termination value) x Sum of reductions/Total decline

The term termination value generally refers to the amount received when the balance adjustment event occurs. However, per section 40-300, it could also be the market value or another amount.

The term cost generally refers to the amount the depreciating asset is purchased for plus expenditure to bring the asset into present condition and location e.g. installation costs. Refer to Subdivision 40-C for further guidance.

The term total decline refers to the decline in value of the depreciating asset since the taxpayer started to hold it.

The term sum of reductions refers to amounts by which a deduction is reduced under section 40-25 and, if relevant, section 40-27. In section 40-25, a taxpayer is entitled to deduct an amount equal to the decline in value of a depreciating asset held any time during the income year. However, the deduction amount must be reduced by the part of the asset’s decline in value that is attributable to use of the asset (or installation ready for use) for a non-taxable purpose. Put simply, the taxpayer must reduce a deduction amount by any non-business use. Consider the example of Thomas who acquires a depreciating asset on the first day of the income year with a cost of $1,000 and an effective life of 1 year. The asset is used 40% for private purposes. Thomas’ deduction of $1,000 for the income year is reduced by $400 (the sum of reductions). Section 40-25 contemplates other forms deduction reductions.

In section 40-27, there are also deduction reductions (in certain circumstances) for the decline in value of second-hand assets used in a residential investment property, unless the taxpayer’s use of the property to produce assessable income constitutes the carrying on of a business.

Reductions may not be required if the asset is supplied with a new residential premises or where the depreciating asset has been allocated to a low-value pool.

Example

Thomas purchases a depreciating asset for $6,000 on the first day of the income year. The effective life of the asset is 3 years. Thus, using the prime cost method (assuming the asset were used 100% for a taxable purpose and assuming the deduction for decline in value is not accelerated e.g. under the IAWO) the taxpayer would be entitled to a deduction of $2,000 per year (or less if the asset were depreciable part-way through the income year) less reductions. In this instance, the asset had 70% private-use and 30% taxable-use during a particular income year. Thomas acquired the asset after exactly 1 year for $4,500.

Here, the termination value is $4,500. The cost is $6,000. The total decline is $2,000. The sum of reductions is $1,400 (i.e. $2,000 deduction pre-reduction x 70% private-use). As the cost of the depreciating asset is more than termination value, the taxpayer has made a capital loss.

The quantum of capital loss is determined using this formula:

 (Cost – Termination value) x Sum of reductions/Total decline

Accordingly, the capital loss here is $1,050 i.e. [$6,000 – $4,500] x $1,400 / $2,000.

Now let’s work through some variations on the above example.

Let’s assume the depreciating asset was instead used 100% for a taxable use. The capital loss here would be: $1,500 i.e. [$6,000 – $4,500] x $2,000 / $2,000.

Now let’s revert to the original facts but assume that the asset had a termination value of $6,500. In this instance, the termination value exceeds cost which means there is a capital gain. The capital gain is $350 i.e. [$6,500 – $6,000] x $1,400 / $2,000.

Let’s now assume that Thomas purchases an investment property on capital account which comes with a second-hand depreciating asset. The depreciating asset has an effective life of 10 years and an attributed cost of $10,000. The taxpayer is prevented from claiming a deduction for decline in value under section 40-27. The asset is sold after 730 days for $1,000. Here, the sum of reductions is $2,000 and the total decline is also $2,000. The termination value is $1,000 and the cost is $10,000. The capital loss is therefore $9,000 i.e. [$10,000 – $1,000] x $2,000 / $2,000.

You can see that CGT event K7 potentially provides a taxpayer with the benefit of a capital loss recognition despite section 40-27 potentially preventing the deduction.

Exceptions

In addition to the exceptions addressed above, a capital gain or loss will be disregarded if the depreciating asset is also a pre-CGT asset.

In addition, CGT event K7 will not apply where another CGT event happens which has more specific application.

CGT discounts and concessions

Any capital gain which results from CGT event K7 may be discounted under the general CGT discount provided the conditions of eligibility in Division 115 are satisfied. The small business CGT concessions in Division 152 are not available.

This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.