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The Power of Property Depreciation


Many investors are aware of their investment property depreciation entitlements and benefit accordingly. Yet many more, a staggeringly high proportion, are unaware that they are able to claim depreciation as a tax deduction and subsequently miss out on the available tax credits.

In this edition of Property Insight, we hope to eliminate the confusion surrounding this often misunderstood topic and increase your understanding of how to claim your depreciation benefits — even if you haven’t claimed before.

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Four out of five investors are missing out...

As director of BMT Tax Depreciation, Bradley Beer, points out: “Research shows that 80% of property investors are failing to take advantage of property depreciation and are missing out on thousands of dollars in their pockets.”

Many investors fall into the trap of thinking that depreciation is only relevant for brand new properties. Whilst the benefits are greater for newer properties (we’ll explain why shortly), it’s generally still worth while claiming your depreciation on older properties. 

Organising a depreciation report for your investment property could be the difference between turning a negatively geared investment into a neutral or positively geared asset and possibly providing you with a positive cash flow against a property with negative cash flow.


What exactly is property depreciation?

As a building gets older, items wear out and loose value – they depreciate. The Australian Taxation Office (ATO) allows property investors to claim this as a deduction, otherwise known as a tax credit. Unlike other deductions such as interest on your loan where you need to outlay money in order to make a claim, this type of deductions is considered a “non-cash tax deduction”. It requires no new cash outgoings on your behalf, save the initial set-up cost of a Quantity Surveyor’s report. 

There are essentially two types of depreciation investors can claim:

  1. Capital Works Allowance (Division 43)
  2. Plant and Equipment (Division 40)

The capital works allowance is a deduction available for the structural element of a building including fixed irremovable assets; this is commonly referred to as the ‘building write-off’. For calculating the depreciation entitlement, the value of the building is reduced yearly for up to 40 years at 2.5% pa. 

The plant and equipment element is a deduction available for removable assets including items like carpet, hot water systems, blinds, light fittings and many others. With plant and equipment, the deduction is calculated over the life of a fixture or fitting (generally 5-10 years). For example, a dishwasher that is allocated a life span of 5 years, may be depreciated at 20% per year.


 

New versus old properties

New properties have a higher depreciation rate than older properties. It’s one of the principal reasons why many savvy investors prefer brand new properties in their portfolios.

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; 2.5% of the structural cost of a building can be claimed per year for 40 years.

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 5 years old, the new owner will have 35 years left of the building write-off to claim.

Building write-off is governed by the date that construction began. If a residential building was built before 18 July 1985, 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, including any recent renovations, even if that renovation was carried out by a previous owner.

A real difference in deductions

Table 1.0 shows the difference in deductions for depreciation of fixtures, fittings and building write-off between similar new and old properties. The difference between the ‘older property’ and the ‘new property’ in the first year, is a whopping deduction of $8,955! 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 not be misjudged or under estimated.


Table 1.0

 Older Property
(Minor Renovations, Year of Construction 1974)
Purchase Price  Depreciation Year Depreciation Year Depreciation Year Depreciation Year Depreciation Year
   1 2 3 4 5
 $460,000 $7,127 $6,018 $5,241 $4,188 $3,786
Recent Property
(Year of Construction 2005)
Purchase Price  Depreciation Year Depreciation Year Depreciation Year Depreciation Year Depreciation Year
   1 2 3 4 5
 $460,000 $9,874 $8,812 $7,659 $6,554 $5,917
 Older Property
(Year of Construction 2012)
Purchase Price  Depreciation Year Depreciation Year Depreciation Year Depreciation Year Depreciation Year
   1 2 3 4 5
 $460,000 $16,082 $14,371 $12,347 $11,238 $10,563


Haven’t claimed your deductions?

If you’re part of the 80% of property investors who haven’t claimed your entitlements, don’t despair. Property owners can claim missed deductions from two-year-old tax returns. The ATO permits you to amend tax returns for the past two years which allows you to claim any depreciation from this period. 


How do I determine my depreciation entitlements?

To maximise your depreciation returns, you should engage the services of a Quantity Surveyor who will provide a depreciation report specific to your investment property. Always make sure they are a registered tax agent as you will require an ATO compliant tax depreciation report for submission. 


The process to organise a depreciation report is extremely simple. 

  1. Engage a Quantity Surveyor who will ask some basic questions about the property that may include:
    • Your settlement date 
    • Purchase price 
    • Access details for inspection (e.g. property manager) 
    • Any information pertaining to improvements or additions made to the property including completion 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) 

  2. The Quantity Surveyor will organise a site visit, usually through the onsite manager or the property manager. 

  3. From here, the depreciation report for your investment property will generally take two weeks to complete. 

  4. The report will be sent to you and your specified accountant, who will reference this report at tax time. 



A quick tip: Don’t forget to claim the Quantity Surveyor’s fee at tax time as this is 100% tax deductible.


Why not consider a Pay As You Go (PAYG) variation?

Often overlooked by investors, the PAYG system is a great way to increase fortnightly cash flow throughout the year. The PAYG method of tax collection was introduced in July 2000 to replace previous versions of the same systems, such as Pay As You Earn (PAYE). The system gives the option of claiming back tax regularly, rather than in one lump sum at the end of the financial year.

A PAYG variation means that the property owner’s employer will reduce the amount of tax withheld to reflect set deductions like depreciation on a rental property. In essence, it is a way of decreasing the amount of tax paid by the investor each pay period. It’s important to note that submitting the PAYG variation does not replace a normal tax return. A tax return still needs to be filed at the end of the year to calculate the actual amount of tax liability. Your PAYG instalments for the year are credited against your assessment.

The flexibility provided to you through a PAYG variation, (combined with depreciation deductions identified by a Quantity Surveyor), can be of great help in managing the fortnightly cash flow of an investment property.


Let’s consider a hypothetical situation

A typical $400,000 investment property would show an average annual loss (or deduction) of $35,000 and an average income of $20,000 for the first 5 years. The deductions include costs such as interest on a $350,000 mortgage, management fees, maintenance and property depreciation. The total loss (income minus expenses) will result in a deduction for the owner of $15,000. In the 37% tax bracket the $15,000 deduction could generate a tax return (or credit) of $5,550. Under a PAYG variation, the investment property owner can adjust their fortnightly pay to anticipate this return, adding $213 to their pay packet each fortnight.


The final word on depreciation

It’s always worth seeking advice about the depreciation potential of a property regardless of age. The deductions are not as high on older properties but there are usually enough deductions to make the process worthwhile. Of course, buying a brand new property for the depreciation benefits alone is not recommended – seek brand new properties in locations close to core infrastructure and with high rental demand – this will maximise your overall returns.

If you’re one of the many Australian property investors not taking advantage of your depreciation incentives, we urge you to talk to a Quantity Surveyor in order to maximise your investment capital.


Depreciation information supplied by BMT Tax Depreciation. Bradley Beer (B. Con. Mgt, AAIQS, MRICS) is a Director of BMT Tax Depreciation. Please contact 1300 728 726 or visit www.bmtqs.com.au for an Australia wide service.

 

DISCLAIMER: Whilst the publisher and author believe that the information contained in the publication is based on reliable and researched information, no warranty is given as to its accuracy and persons relying on this information do so at their own risk. Anyone who intends to use the information as the basis for making financial or business decisions should first obtain advice from a qualified professional person. This article is published on the understanding that neither the publisher nor the author - is responsible for the results of any action taken on the basis of the information published; and is not engaged in rendering legal, accounting, professional or other advice or services. The publisher and author expressly disclaim all liability and responsibility to any reader of this publication as a consequence of anything done, or not done, by a reader relying upon any part of this publication. (C) This article may not be reproduced in full or in part without the specific written consent of Which Property? and the Author.

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