An entity must analyze the deferred **tax in the investment property** from two perspectives:

The first perspective is presented when the company **can’t measure the fair value** in the **subsequent measurement** of an investment property reliably.

Therefore, the entity chooses the **cost model** as its accounting policy.

And the other perspective occurs when an **entity can reliably determine fair value** on subsequent measurement of an **investment property.**

## Deferred tax when fair value cannot be reliably estimated.

**IAS 40,** specifically in paragraph 30, establishes that when an entity **cannot reliably measure the fair value** of an investment property, it must use **the cost model.**

Now, what does it mean that an entity chooses the **cost model?**

This means that the subsequent measurement of this type of asset must be regulated by the accounting principles established in **IAS 16**, **IFRS 16**, or **IFRS 5.**

The choice of the **cost model** or the **fair value model** may imply a significant change in the calculation of the **deferred tax.**

Before explaining theoretically and with a practical example the repercussions of **deferred tax on investment properties** using the **cost model,** it is essential to define what deferred tax is.

**Deferred tax** is the value that an entity expects to recover in the future due to the **temporary differences** arising between an accounting base and a **tax base.**

When we refer to the use of the** cost model,** we refer to the temporary differences presented between the accounting base and the tax base of an **investment property** due to the use of different **useful lives tax** and **accounting.**

*For example, an entity acquires a warehouse to lease to third parties.*

*The entity cannot reliably measure the asset’s fair value.*

Therefore, the entity** chooses the cost model** as its accounting policy and depreciates the asset based on a useful accounting **life of 50 years,** according to **IAS 16.**

On the other hand, the maximum **tax period** that an entity can depreciate an investment property is 30 years in the **company’s jurisdiction.**

As the years go by, the accounting carrying amount and the tax c**arrying amount will be different.**

This results in a temporary difference that **causes a deferred tax.**

It is essential to say that from an accounting point of view, **investment properties are not depreciated** as long as the entity can reliably measure the fair value; however, this is not the case.

### Practical example 1: Tax deferred investment properties:

**In year 1, an entity acquires a warehouse for 1,000,000, with a useful life of 50 years.**

**The company uses this asset to obtain income as an operating lease.**

**The entity cannot reliably establish the fair value of the investment property and therefore chooses the cost model as its accounting policy for subsequent measurement.**

**Under the tax regulations in the jurisdiction where the entity operates, buildings are depreciated based on a useful life of 30 years.**

**The current tax rate for year 1 is 34%, while for year 2, it is 42%.**

**The profit and loss statement from the accounting and tax point of view is shown below:**

As you can see, **the fiscal income statement** is different from the **income statement in IFRS.**

This difference occurs because the **useful life** calculated to obtain fiscal depreciation is different from the one calculated for **accounting effects.**

** The deferred tax** calculation is shown below:

**The calculation of the carrying amount** for year one is obtained by dividing the historical cost of the asset over a useful life of **50 years.**

This results in a monthly **depreciation of 20,000,** which means an accounting carrying amount for year 1 of **980,000.**

In the same way, the same procedure is **carried out for tax purposes.**

But based on a useful** life of 30 years.**

This is equivalent to a **monthly depreciation of 33,000 and a carrying amount of 966,667.**

Therefore, the temporary difference for year 1 **is 13,333.**

**That is, a deferred tax liability of 4,533 (13,333 * 34%).**

Remember that if the accounting base is greater than the tax base, it is a temporary taxable **difference, and it must be accounted for as a liability.**

However, if, on the contrary, the accounting base is less than the tax base, it is a temporary **deductible difference,** and it should be accounted for as an asset.

For year 2, the t**emporary difference is 26,667.**

This is equivalent to a deferred **tax liability of 11,200.**

To determine the deferred tax expense in year 2, we must deduct the initial balance of the **liability recognized in year 1.**

This results in a **deferred tax expense in year 2 of 6,667 (11,200 – 4,553).**

The reconciliation of the **deferred tax** is as follows.

In this way, the reconciliation begins with the current **fiscal tax expense for years 1 and 2.**

The entity must add the expense for **temporary differences** for each year to this value.

That is, for year 1, the **tax expense deferred is 13,333 (x34 %) = 4,533 and for year 2 it is the difference between the deferred tax between years 1 and 2, better said: 11,200 – 4,533 = 6,667.**

On the other hand, within the reconciliation, it’s necessary to consider the increase in the tax rate from **34% to 42%**

This effect is calculated based on the temporary difference from the previous year.

In other words, **13,333 multiplied by the difference between the tax rates from one year to another, which is equivalent to 8% (42% – 34%)**

This operation results in an income due to an increase in the tax rate equal to **1,067.**

In summary, the **tax expense of 36,400, plus the expense of the period of 6,667, less the adjustment for the increase in rates of 1,067,** should be equal to the expense for accounting income tax **(100,000 * 42%) = 42,000.**

* Calculation of the effective tax rate:*

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It’s necessary to start from the **tax rate** applied each year.

To this percentage, you must add the **tax effect of the expenses** that are not deductible to calculate the taxable profit.

In this example, there are no such expenses.

On the other side, we must also deduct the** increase in the rate from one year to another.**

The sum of the items mentioned above **must equal the effective rate.**

**The effective rate** is determined using the following formula:

** Effective rate: Current tax + deferred tax / Accounting profit**

Then, for year 1, the effective rate is **34%** of **current tax** + the **expenses that are not deductible** when calculating the taxable profit, **equal to zero.**

And the effect on the **increase in the rate** is also **zero** for year 1.

**This results in an effective tax rate of 34%.**

**This percentage must equal to the current tax of (29,467 + 4,533) / 100,000 = 34%.**

We repeat the same procedure for year 2 as follows:

Applicable tax rate of **42%** plus expenses that are not deductible and the **effect of the tax rate increase in both years.**

In this way, the tax rate of 42%, the expenses that are not deductible when calculating the taxable profit equal to zero, plus the effect of the increase in the rate **equivalent to 1.1% (1,067 / 100,000) is equal to 43.07%.**

To check this operation the effective rate percentage **of 43.07% must be equal to (36,400 + 6,667) / 100,000 = 43.07%**

### Deferred tax when the fair value can be reliably estimated.

The other scenario related to **deferred tax on investment properties** occurs when an entity can measure the **fair value reliably of these assets.**

In most jurisdictions, the increase in the fair value of an investment **property is not taken into account in calculating the tax base of these assets.**

In this second scenario, under the **tax regulations,** the temporary differences will arise as a consequence of the difference between the tax base and the accounting base product of the depreciation and the **valuations of the assets; let’s look at the following practical example.**

## Practical example 2: Tax deferred investment properties:

**An entity acquires a building for 1,000,000.**

**Its useful fiscal life is 30 years, and the company maintains the asset to obtain capital gains.**

**At the end of year 1, the fair value of the investment property is 1,300,000, and in year 2, the fair value is 1,500,000.**

**The tax rate for year 1 is 34%, and for year 2, it is 43%.**

**The fiscal and accounting income statement is shown below:**

Under paragraph 35 of **IAS 40,** should recognize changes in fair value in profit and loss.

The **deferred tax** calculation is as follows:

The reconciliation of the **deferred tax** and the reconciliation of the effective rate is as follows.

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