Deferred tax on investment property

Why does investment property create deferred tax?

Under the fair value model, gains go to profit or loss each year, but most tax systems tax a property gain only when the property is sold, and some give tax allowances on buildings that are clawed back on sale. The carrying amount and the tax base therefore drift apart, creating a taxable temporary difference. IAS 12 requires deferred tax on it, measured using the rates and tax base consistent with how the company expects to recover the property.

What is the sale presumption?

For investment property measured at fair value under IAS 40, IAS 12 presumes that the carrying amount will be recovered entirely through sale. The presumption, added in 2010, removed the need to judge for each property how much value would come from rent and how much from an eventual sale. It also applies to investment property acquired in a business combination if the company will then measure it at fair value.

Deferred tax on investment property: a worked example

A company bought an office building for CU 100 million and has claimed 20 million of tax allowances on it, so its tax written-down value is 80 million. It is now carried at fair value of 140 million. In this tax system, allowances are clawed back on sale and taxed at the 25% income tax rate, and the gain above original cost is taxed at a 15% capital gains rate.

Measuring the whole difference at the income tax rate, as if the property would be recovered through rent, would give 15 million, overstating the liability by 4 million. If gains on property were exempt from tax altogether, only the clawback would remain. The deferred tax charge for the year is the movement in this liability and goes to profit or loss, following the fair value gain.

When is the presumption rebutted?

Only when the property is depreciable and held within a business model whose objective is to consume substantially all of its economic benefits over time, rather than through sale. An example is a building on a short leasehold that the company will hold until the lease runs out. Land is not depreciable, so the presumption is never rebutted for land: a property with a rebutted presumption is split, with the land measured on sale and the building on use. Rebuttal is rare for property investors, whose portfolios are actively managed and sold.

What if the property is held in a company that will be sold?

Properties are often held in single-asset companies and sold by selling the shares, which may be taxed differently or not at all. The IFRS Interpretations Committee confirmed in 2014 that, in the consolidated accounts, deferred tax on the property is still measured by reference to the property itself, as if it were sold directly. Deferred tax on the parent's investment in the subsidiary is a separate question, and is not recognised if the parent controls the timing of the reversal and it is probable that it will not reverse in the foreseeable future. Any discount a buyer would demand for the deferred tax is reflected only when the shares are sold.

Is there deferred tax when property is bought?

It depends on whether the purchase is a business combination. Buying a property, or a company holding little more than a property, is often an asset acquisition, and the initial recognition exemption then applies: no deferred tax is recognised on differences between the purchase price and the tax base on day one. Later fair value movements create deferred tax in the usual way. In a business combination, deferred tax is recognised at acquisition, and it increases goodwill. See purchase price allocation.

Why do property companies adjust NAV for deferred tax?

IAS 12 does not allow deferred tax to be discounted, even if a sale is decades away, and many investors do not expect to pay it at all because properties are sold in tax-efficient structures. Property companies therefore often present net asset value measures, such as EPRA net tangible assets, that exclude deferred tax on properties not expected to be sold. These are alternative measures; the IFRS balance sheet keeps the liability.

What about REITs, the cost model and US GAAP?

A REIT whose property gains are exempt measures deferred tax at nil; see REIT accounting. Under the cost model there is no presumption: deferred tax reflects the difference between depreciated cost and the tax base, usually measured on recovery through use. US GAAP has no sale presumption, but because real estate is held at cost, temporary differences arise mainly from tax depreciation. See temporary differences, deferred tax under IAS 12 and investment property: fair value or cost.

This guide is general information. It is not tax or legal advice for your situation.