How Tax Depreciation Can Help Your Investment Property
The 2016/2017 financial year is kicking off and, even though Accountants are still in the process of submitting returns, it may be prudent for property owners to get on the front foot and start thinking about July next year.
One tool at the disposal of property investors that may not be used to its full advantage is a depreciation schedule.
What is a depreciation schedule you ask?
Like everything, buildings get older; they wear and tear, they depreciate. The value that an item depreciates can be claimed as a taxable deduction by any owner who generates an income from their property.
However, the depreciation of the property is largely unclaimed by property owners. According to BMT Tax Depreciation, 80% of investors fail to claim their depreciation deductions and therefore don’t maximise their deductions.
According to Bradley Beer of BMT Tax Depreciation, “awareness is part of the issue”.
“Because depreciation is a non-cash deduction and a paper loss rather than a capital loss, unless investors are informed about their eligibility to claim it, it can easily be missed.”
As opposed to other expenses incurred with maintaining a property such as rates, insurance, or repairs, owners don’t need to spend any money in order to claim the deduction.
Tax depreciation is an important part of managing the property, allowing owners to increase their deductions.
“By claiming depreciation the investor reduces their tax liability and therefore improves their cash return. The additional money will provide the investor with additional cash flow to offset any costs involved in holding the property,” said Mr Beer.
There are two types of depreciation allowances defined by the Australian Taxation Office (ATO):
- Division 40 plant and equipment depreciation
- Division 43 capital works allowance
Plant and equipment depreciation refers to easily removable fixtures or fittings. The ATO allows over 6,000 items that property owners can claim depreciation for. This includes items such as carpets, air conditioners, or hot water systems. The depreciation of plant and equipment assets is calculated based on an effective life and depreciation rate the ATO set for each individual asset. The ATO provide rates using two methods: the prime cost and the diminishing value. Investors can choose one of these two methods from which to claim depreciation for these assets.
The rate at which capital works deductions apply is dependent on the age of the property and its use. The ATO stipulates that investors can only claim capital works for residential properties in which construction commenced after the 15th of September 1987. For commercial properties, this date is the 20th of July 1982.
In residential properties the capital works deduction will be claimed at 2.5 per cent per year for forty years from the construction completion date. Depending on the property’s use a commercial property can either be claimed at 2.5 or 4 per cent.
Owners of buildings constructed prior to these dates may still be eligible for capital works, particularly if the property has since undergone renovations. It is best to check with a Quantity Surveyor whether a property is eligible and to obtain a tax depreciation schedule to make a claim.
The Quantity Surveyor will conduct an inspection of the premises and compile a tax depreciation schedule identifying all of the deductions available for both capital works and plant and equipment assets.
“When the owner completes their annual income tax return, their Accountant will use the deductions outlined within the schedule to process their depreciation claim,” Mr Beer said.
This will then mean that the property owner will be able to increase their deductions, and in turn, improve their tax refund.
For example, a property owner may make a loss of $10,000 per annum from their investment property after the total expenses are deducted from the annual income. By using a depreciation schedule, the owner will be able to calculate the addition expenses they have incurred through the wear and tear of the property.
In this example, the property owner may find $5,000 worth of additional deductions, meaning their total deductions increase to $15,000. As a result, the owners overall refund will increase, which will decrease the overall loss on the property.
Quantity Surveyors are one of the few people who can calculate costs for depreciation purposes and owners will need to engage the services of a Quantity Surveyor in order to lodge a depreciation schedule.
As always, engaging a property professional can assist in arranging a network of other services to allow you to get the most out of your property purchase, sale, management, or investment.