John purchased an investment property for $500,000 in 2020 and sells it in 2024 for $700,000. He has claimed $40,000 in depreciation over the ownership period. What is his capital gains calculation before any CGT discount?

Q: What is the correct answer to: John purchased an investment property for $500,000 in 2020 and sells it in 2024 for $700,000. He has claimed $40,000 in depreciation over the ownership period. What is his capital gains calculation before any CGT discount?

The correct answer is $240,000 capital gain. Option B correctly applies the depreciation recapture principle. The calculation is: Sale price ($700,000) minus cost base ($500,000) equals $200,000, plus depreciation recapture ($40,000) equals $240,000 total capital gain. Under Australian tax law (Income Tax Assessment Act 1997), depreciation claimed on investment properties reduces the cost base, so it must be added back to determine the true capital gain before any CGT discount is applied.

Q: What background knowledge is needed for this Finance Taxation question?

Capital gains tax on investment properties involves calculating the difference between sale price and cost base, with adjustments for depreciation claimed. Under the Income Tax Assessment Act 1997, depreciation claimed on buildings and fixtures reduces the property's cost base for CGT purposes. This creates a 'depreciation recapture' effect where the depreciation must be added back to the capital gain calculation. The CGT discount (50% for individuals holding assets over 12 months) is applied after calculating the gross capital gain. This ensures taxpayers cannot double-dip by claiming depreciation deductions during ownership while also reducing their capital gain liability on disposal.

Q: What is a good way to remember the answer to this Finance Taxation question?

Remember DRAG: Depreciation Recapture Adds to Gain. Think of depreciation as a weight that 'drags' your cost base down during ownership, but when you sell, you must 'drag' it back up by adding it to your capital gain. The depreciation you claimed was borrowed tax relief that must be repaid through higher capital gains. When you see a CGT question with depreciation claimed, immediately think 'DRAG' and remember that depreciation adds to the capital gain calculation. Look for the depreciation amount in the question and add it to the basic gain (sale price minus purchase price).

Q: What exam tip applies to this Finance Taxation question?

Always check if depreciation has been claimed on investment properties. If yes, add the depreciation amount to the basic capital gain calculation (sale price minus purchase price). Don't subtract depreciation - it always increases the taxable capital gain.

Q: How does this Finance Taxation concept apply in Australian real estate practice?

Sarah owns a rental property purchased for $600,000. Over five years, she claims $25,000 in building depreciation deductions, reducing her annual taxable income. When she sells for $750,000, her accountant explains that while the basic gain appears to be $150,000, she must add back the $25,000 depreciation claimed, resulting in a $175,000 capital gain. This depreciation recapture ensures she doesn't benefit twice from the same tax advantage and affects her decision about whether to hold the property longer to qualify for the 50% CGT discount.

Question

Finance TaxationCGTHARD

John purchased an investment property for $500,000 in 2020 and sells it in 2024 for $700,000. He has claimed $40,000 in depreciation over the ownership period. What is his capital gains calculation before any CGT discount?

Answer Options

A

$200,000 capital gain

B

$240,000 capital gain

C

$160,000 capital gain

D

$180,000 capital gain