Owning an investment property is a big responsibility, and there are many things that you need to take into consideration. One of the biggest missed considerations is depreciation – depreciation refers to assets wearing out as they get older. The ATO allows owners of income-producing properties to claim depreciation as a tax deduction. The two tax deduction claims can be made under two categories – capital works and plant and equipment depreciation. In this article, we will talk about these deductions in more detail so that you have an understanding of how depreciation affects your property.
Property depreciation is a non-cash deduction that property owners can claim. Property depreciation refers to the depreciation of the structure and assets within a property, such as carpets or air conditioning units.
We apply general depreciation rules to calculate your depreciation deduction unless your asset is eligible for the instant asset-write off or simplified depreciation rules for small businesses. The ATO prescribes two methods – the prime cost method and the diminishing value method. Both can be used to claim your property depreciation.
Can an accountant calculate depreciation?
No, depreciation is something that only a specialist quantity surveyor can calculate and prepare a tax depreciation schedule. The first step for calculating depreciation deductions is to identify your asset’s cost base and its adjustable value.
The investor’s accountant will use this tax depreciation schedule to determine their deductions each financial year. These can reduce the investor’s taxable income, meaning they pay less in taxes and penalties!
What can an investor claim?
Depreciation deductions are split into two distinct categories:
- Division 43 capital works allowance
- Division 40 plant and equipment depreciation
The capital works allowance relates to claims for the wear and tear that occurs to your building structure of the property and some fixed items. This includes things like roofs/walls; doors (internal or external) kitchen cupboards bathroom tubs and toilet bowls. Anything built after September 1987 will entitle you to a deduction of 2.5% per year. You can claim this rate up until 40 years from completion!
Plant and equipment depreciation can be claimed for the easily removable fixtures, fittings or appliances found within a building’s structure. The Australian Tax Office recognizes more than 6,000 different depreciable assets. Some examples are carpeting and blinds which can be claimed for in your tax return! There are also air conditioners, hot water systems smoke alarms ceiling fans – all these things will decrease over time too so make sure you keep records of when they were installed or purchased if it’s less than 5 years ago.
How does the 2017 depreciation legislation changes impact property depreciation?
Depreciation legislation changes made in 2017 mean that owners of second-hand residential properties (where contracts exchanged after 7:30 pm on 9 May 2017) can no longer claim depreciation on their existing plant and equipment assets. That means, for example, if you own an existing kitchen with state of the art cooking appliances like a stove, dishwasher and oven – sorry but they’re off-limits to depreciate now!
On average, 85 to 90 per cent of total depreciation claims are for capital works. When an investor purchases new plant and equipment for the investment property they can still claim these items. It is imperative that you provide the tax receipts to your accountant in the year of purchase so these items can be added to your tax return and increase the deprecation tax deductions.
How does depreciation differ on Residential, Commercial and Fragmented Investment Properties?
Every property is different! Each depreciation schedule is prepared on a per property basis. The primary difference between residential and commercial property depreciation tax deductions is that both the owner and tenant can claim depreciation on commercial properties like farms, warehouses, hospitals, offices entertainment venues like restraints and hotels. The depreciable categories of capital works and plant and equipment are the same.
When I connected with CEO of BMT Quantity Surveyors Bradley Beer to discuss all things depreciation on the Bricklet Buzz he informed me that there are huge advantages in property fragments depreciation. Due to the style of ownership through the process of property title fragmentation, all the plant and equipment are also fragments at the same percentage as the property title.
If an $800,000 two-bedroom unit is fragmented into 40 Bricklets valued at $20,000 each then each fixture or fitting (plant and equipment) is also fragmented into 1/40 or each Bricklet owner owns 2.5% of each item. The huge benefit here is that if any item is valued at less than $300 the owner can depreciate 100% of that value in the first year. When Brad ran the numbers here are the results: (insert table)
BMT has created a great tool for investors to calculate cash flow called PropTech (insert link in app store). Use PropCalc to determine the cash flow needed to own a property, either your next home or investment property.
Can I claim depreciation on old properties or is it just new ones?
The law changed in 2017 which makes a huge difference between claiming depreciation on the new and second-hand property. The plant and equipment component of a deduction schedule includes ovens, dryers, shades, air-conditioners, televisions carpets lounge suites and blinds. But construction permits are no longer subject to such changes on building structures. This part of this schedule includes things like cement and bricks so you should still receive deductions for these things of your property. Investors in new properties may continue to claim full depreciation on plant and equipment as well as building allowance.
A case study in depreciation
Samantha and Patrick recently bought a block of land each in the same new land subdivision release. They then approached the same builder to construct the same properties as investments for $550,000. Samantha is an executive who decided she didn’t have time to organise or worry about a tax deduction schedule. Patrick obtained a schedule and saved $10,800 in the first year in comparison to Samantha. The tax depreciation schedule provided her supplemental benefits of $20,000 in deductions which she used for this savings.
The above case studies are for illustrative purposes only and although the calculations are accurate, may not apply in the same manner to your circumstances. We are aware that there may be possible amendments in respect of tax lodgement.
How does property renovation impact depreciation?
Renovating a property is one strategy that can increase your profit and tax depreciation entitlement. When you carry out renovation work on investment, many aspects of it are entitled to claims in certain categories such as construction costs or upgrading plant and equipment with new features like tiling entire bathrooms and kitchens or single items such as a toilet, carpets, blinds and door handles!
‘Scrapping’is what the industry calls the process of discarding plant or equipment and/or capital works items that are no longer needed within your investment property.
Before throwing anything away, make sure you get a depreciation schedule written up. This will ensure that your accountant can take advantage of all tax allowances available to you! Investors should be aware that they can assign a value to any item they plan to dispose of prior to the commitment of the renovation and claim it as a tax deduction.
The final mistake is not getting an updated depreciation schedule once the property is renovated.
Just remember– in order for you to claim the residual value of the item, the item needs to be income-producing prior to being ripped out, and the property needs to be income-producing after the renovation has occurred.
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