Did you know that over 50% of property investors are missing out on thousands of dollars each year in unclaimed tax deductions on their investment property? This is a windfall for the ATO but a financial burden on the unwary property investor. Every year we have new property investor clients that come to us with existing rental properties to find that they have not claimed any tax deductions. In fact, most of them didn't even know that they could claim a tax deduction. This is common with property investors that make their previous home an investment property or rent out their home whilst living overseas or on renovations made to their property.
That's why we have created this guide with easy to understand video presentations with real life examples to help more property investors understand what tax deductions are available to them. By understanding the basics you will be better able to discuss with your accountant the best way to maixise your tax deductions.
These deductions could save you thousands of dollars each year which you can put towards reducing your mortgage faster or improving your investment property which will increase your rent and improve your cash flow further. This is the fundamental strategy used by successful property investments to maximise their negative gearing benefits. But this strategy may not be suitable for property investors looking to sell their property in the near future as it may have capital gains tax implications so make sure you discuss your situation with your tax advisor or accountant.
So let's hear what one of the industry's leading providers of depreciation reports BMT, has to say about the most common questions asked by property investors:
What is Depreciation?
In simple terms, as a building gets older and items within it wear out, they 'depreciate in value'. Like wear and tear. Because owning an investment property is like running a business where rent is income that is taxable, then so too the property is like your tools of trade which can be depreciated over time and an allowance is made for the subsequent tax deduction.
The ATO allows Property Investors to claim a deduction to the building and plant and equipment items it contains. Depreciation can be claimed by any owner of an income-producing property whether the property is new, old or previously a family home. This deduction essentially reduces the investment property owner's taxable income so they pay less tax which leaves more money in the hands of the investor!
How does depreciation work?
What is a Quantity Surveyor?
A quantity Surveyor is a qualified pofessional who can identify, quantify and determine what can be deducted and the amount of the deduction. They will prepare a detailed report that is ATO approved which your accountant can use to calculate your deductions when preparing the tax return for your investment property.
Why use a Quantity Surveyor?
In most instances a Quantity Surveyor will identify more deductible items and will substantiate these deductions so that you comply with the ATO requirements
If you don't already have a property depreciation report or you require an updated report, we can arrange one for you at a discounted trade rate. Just click here to send us an email request.
What is Plant & Equipment?
Plant and equipment items are basically items that can be ‘easily’ removed from the property as opposed to items that are permanently fixed to the structure of the building. Plant items include mechanically or electronically operated assets, even though they may be fixed to the structure of the building. Some examples of plant and equipment items include:
- Hot Water Systems
- Garage Door Motors
- Freestanding Furniture
- Air Conditioning
What is Building Write-Off Allowance?
The building write-off allowance is an allowable deduction for the value of the building. It is based on historical building costs of the building and includes the bricks, mortar, walls, flooring, wiring etc. From the date of construction completion, the ATO has determined that any building eligible to claim depreciation has a maximum effective life of 40 years. Therefore, investors can claim up to 40 years depreciation on a brand new building, whereas the balance of the 40 year period from construction completion is claimable on an older property. The allowance amount equates to 2.5%pa of the total value.
What is the difference between Plant & Equipment and Building Write-Off Allowance?
What is the difference between Repairs and Capital Improvements?
It is important to understand the difference between a repair and a capital improvement because they are treated differently by the ATO. A repair (such as replacing the heating element on the stove or patching a settlement crack in the wall) can be expensed in the same tax year that it is incurred where as a capital item must be depreciated over a number of years in accordance with the ATO guidelines.
Can refurbishment costs be depreciated?
Yes they can.
Can previous renovation costs be claimed?
Yes. Anything in the property that is part of a previous renovation will be estimated by our quantity surveyors and depreciated accordingly. This includes items that are not obvious e.g. New plumbing, water proofing, electrical wiring etc. For capital improvements to qualify for the Division 43 construction write off allowance, they must be completed after the 27th of February 1992.
What is Scrapping?
Scrapping is the removal and disposal of any potentially depreciable assets from an investment property. In other words, it is the demolition of any existing structure or fixture onsite that would have been eligible to claim deductions for depreciation. Scrapping of existing structures onsite is a very effective method of obtaining deductions within our tax system. It can provide additional tax credits for investors who demolish or dispose of existing buildings or any part of it which were owned as an investment asset and eligible to produce income.
Essentially, if an item is scrapped the amount that is yet to be written off for a particular asset (the residual value) can generally be claimed as a 100% tax deduction at the time of disposal.
Can low cost capital items be written off?
Yes in some cases, this is know as Low Cost pooling - A low cost asset is a depreciable asset that has an opening value of less than $1000 in the year of acquisition.
That is, if the opening value of an asset is greater than $1000 in the year of acquisition but the value remaining after depreciating over time (opening value less depreciation in year 1 less depreciation in year 2 etc) is now less than $1000. Assets meeting this classification are placed in an itemised pool.
Pooling is often used in conjunction with the diminishing value method to maximise deductions in the first 5 years of the depreciation report.
Can furniture in a property be tax deducted?
Yes in most cases.
Are common areas deductible?
Yes in most cases.
How does claiming depreciation effect Capital Gains Tax?
If my property was built before 1985, is it too old for a depreciation report?
No. Contrary to popular belief:
- Both new and old properties will attract some depreciation deductions. A common myth is that older properties will attract no claim.
- If a property owner has not been claiming or maximising tax depreciation deductions, the previous two financial year’s tax returns can be adjusted and amended.
What is the difference between Prime Cost and Diminishing Value methods of depreciation?
Two methods can be applied when depreciating property, the Diminishing Value (DV) and Prime Cost (PC) method. The intentions of the property investor will determine which depreciation method will be most suitable for them.
Under the diminishing value method the deduction is calculated as a percentage of the balance you have left to deduct. The formula for calculating depreciation using the diminishing value method is:
Properties settled pre 10th May 2006
Plant’s effective life
Properties settled on or after 10th May 2006
Plant’s effective life
*Note: On average this change will increase the rate of depreciation by 33%
Under the prime cost method the deduction for each year is calculated as a percentage of the cost. The formula for determining the amount of depreciation deduction under the prime cost method is:
Properties settled pre 10th May 2006.
Plant’s effective life
Which depreciation method is best for me?
It depends on how you want to claim.
If you claim using the Diminishing Value Method (DV), you are claiming a greater proportion of the assets cost in the earlier years of the effective life. For example, if the owner purchased the property for the purposes of a short term investment and planned to sell it in approximately five years time, the DV rate would be a more attractive option to take, as it provides higher returns over the earlier years. If you claim using the Prime Cost Method (PC), you are claiming a lower but more constant portion of the available deductions over the life of the property. If the owner was intending to retain ownership for a longer period of time then the PC option may be more suitable, as it provides a constant projection of what the investor’s tax deductions will be.
Our experience shows that most investors employ the diminishing value method, as depreciation deductions under this method are cumulatively higher over the first five years of ownership.
How do you work out how old the building is?
The age of the building can be determined by obtaining council documents with dates pertaining to the original application approval date or the Occupancy Certificate date, and final inspection date. Similar methods are used Australia wide, however some properties are privately certified...SOme ways to identify the age is to perform historical council searches regarding lodged development applications, as well as Occupancy Certificates and certified final inspections.
Why does the depreciation report only last 40 years?
From the date of construction completion, the ATO has determined that any building eligible to claim depreciation has a maximum effective life of 40 years. Therefore, investors can claim up to 40 years depreciation on a brand new building, whereas the balance of the 40 year period from construction completion is claimable on an older property.
Can I use a Tax Depreciation report as a market valuation?
No. A market value is a service that only a registered valuer can provide. Quantity Surveyors estimate construction costs as well as estimating costs for plant and equipment items.
What information do I need to provide for a Report to be prepared?
Information we require to produce a Tax Depreciation and Capital Allowance report includes the following:
- Your settlement date
- Purchase price
- Access Details for Inspection (E.g. Property Manager or Tenant Details)
- Any information pertaining to improvements or additions made to the property including dates and costs where available
- The date the property became income producing (if you have lived in it as your primary place of residence previously)
This information has been provided by our good friends at BMT & Asscociates Quantity Surveyors.
If you would like us to arrange a depreciation report for your property at a discounted price then click here to send us a request and we will be in contact with you..