Many property investors are aware that they are entitled to claim depreciation. However, a staggeringly high proportion are not capitalising on the available depreciation deductions, subsequently missing out on an increased tax return.
“Research shows 80% of property investors are failing to take advantage of property depreciation and are missing out on thousands of dollars in their pockets,” says Bradley.
Investors often fall into the trap of thinking that depreciation only applies to new properties. While the benefits are often greater for newer properties, it is still worthwhile to claim on older properties. Organising a depreciation schedule could be the difference between turning a negatively geared property investment into a neutral or positively geared asset.
What exactly is property depreciation?
As a building gets older, items wear out – they depreciate. The Australian Taxation Office allows owners of income-producing properties to claim this depreciation as a deduction. Unlike other deductions, such as interest on a loan where you need to outlay money in order to make a claim, depreciation is considered a “non-cash tax deduction.”
There are two types of property depreciation investors can claim:
1. Capital Works Allowance (Division 43)
Capital works allowance is a deduction available on the structural element of a building, including fixed irremovable assets. It is commonly referred to as “building write-off” and includes items such as roofs, windows and doors. When calculating the capital works allowance the building’s historical construction cost is used and 2.5% of this can be claimed each year for up to 40 years.
2. Plant and Equipment (Division 40)
The plant and equipment deduction is available for mechanical or removable assets. This includes items such as carpets, hot-water systems, blinds and light fittings.
For plant and equipment, deductions are calculated using the effective life of each fixture or fitting (generally five to 10 years). For example, a dishwasher may be allocated an effective life of 10 years and will be depreciated at 20% per year (using the diminishing value method of depreciation).
New versus old properties
New properties generally attract higher depreciation deductions than older properties. New properties have new fixtures and fittings, so the starting value of those items is higher, resulting in higher depreciation deductions. The same applies to the building write-off allowance. Construction costs generally increase over time, making building write-off deductions on new buildings higher.
Owners of older properties can claim the residual value of the building up to 40 years from construction. For example, if an investment property is 10 years old, the new owner will have 30 years left of the building write-off to claim. Building write-off is governed by the date construction began. If a residential building commenced construction prior to September 15, 1987, there is no building write-off available. However, investors who own properties built before this date are still able to make a claim on the plant and equipment (fixtures and fittings) within the property and include any recent renovations, even if the renovation was carried out by a previous owner.
The table below shows the difference in deductions for depreciation of fixtures, fittings and building write-off between similar new and old properties.
Though the claim from a new property owner is higher, the example shows that, typically, owners of older investment properties (with minor renovations) will still receive a substantial $7127 deduction in the first year.
For an investor, this deduction will make a real difference in reducing taxable income and making a property cash-flow positive sooner. The power of depreciation should never be underestimated.
How can property professionals assist investor clients?
If your clients are a part of the 80% of property investors who haven’t claimed depreciation entitlements, don’t despair. The ATO permits property owners to amend tax returns for the past two years, allowing them to claim any missed depreciation deductions during this period.
Property professionals should urge their clients to seek advice from a specialist quantity surveyor about the depreciation potential of a property regardless of the property’s age. The deductions are not as high on older properties but there are usually enough deductions to make the process worthwhile.
Property professionals can learn more about the benefits of property depreciation for their clients and how it can improve their client’s cash flow by visiting BMT Tax Depreciation’s property professional’s page by clicking here.