Essentials tips for property investors and landlords to reduce taxable income by claiming depreciation of rental property assets.
What is Tax Depreciation?
As a building gets older and items within it wear out, they depreciate in value. The ATO allows Property Investors to claim a deduction related to the building, and plant and equipment items it contains. Depreciation can be claimed by any owner of an income-producing property. This deduction essentially reduces the investment property owner’s taxable income. So in other words...they pay less tax!
What deductions can I claim?
All ATO specified plant and equipment items as well as building write-off allowance (where the building qualifies) can be claimed.
“According to the Australian Tax Office, 52% of rental property investors don't claim all of their available tax deductions…”
What is the difference between plant and equipment and the building write-off allowance?
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
The building write-off allowance is based on historical building costs of the building and includes the bricks, mortar, walls, flooring, wiring etc.
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.
Why is plant and equipment itemised?
The ATO specifies individual effective lives for all plant and equipment items. Our reports show the estimated cost for each item and its contribution to the depreciation total per financial year. The original building structure and capital improvements, or Division 43, are all depreciated at the same effective life rate, consequently, individual costs for these items aren’t expressed in the report. If required by the ATO, the estimates for division 43 can be justified.
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:
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.
Low Cost pool - A low-cost asset is a depreciable asset that has an opening value of less than $1000 in the year of acquisition.
Low Value Pool - A low-value asset is a depreciable asset that has a written down value of less than $1000. 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 used in conjunction with the diminishing value method to maximise deductions in the first 5 years of the depreciation report.
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. BMT Tax Depreciation conduct the relevant searches required to accurately estimate the age of a building. These include historical council searches regarding lodged development applications, as well as Occupancy Certificates and certified final inspections.
How can BMT Tax Depreciation tell me how much something costs especially how much it cost to build my house 10 years ago?
Quantity Surveyors are one of the few professionals recognised by the ATO to have the appropriate construction costing skills to calculate the cost of items for the purposes of depreciation. BMT Tax Depreciation also prepare cost plan estimates for all types of buildings. That ensures we have the complex skills and data required to accurately estimate construction costs. Construction costs are estimated in today’s market and historically written down to the year of construction using yearly cost indices.
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 claim renovations done by the previous owner?
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 I use a Tax Depreciation report as a market Value?
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 info do I need to provide for a BMT Report?
Information we require to produce a Tax Depreciation and Capital Allowance report includes the following:
Your settlement date
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)
What does the BMT report contain?
A detailed 23-page report includes the following components:
A method statement;
Schedule of Diminishing Value Method of Depreciation;
Schedule of Prime Cost Method of Depreciation;
Schedule of pooled items for the property
Lists all Division 43 (10C & 10D) allowances available from the property;
Detailed 40-year forecast table illustrating all depreciable items together with building write off for both Prime Cost and Diminishing Value methods;
Comparative table of the two methods of depreciation;
Common property items within strata or community title complexes such as lifts and swimming pools are included in the depreciation report for a unit in a multi-unit development;
The report is structured to facilitate the client to be able to amend previous years' returns to re-coup unclaimed depreciation benefits; and
The report is pro-rata calculated for the first year of ownership based on the settlement date so that the accountant has the exact depreciation deductions for each year.
The report will ensure maximum depreciable items are identified and will take into account the pooling of low value items under the uniform capital allowance system. It is valid for the life of the property (40 years) until capital improvements are undertaken.
Want more advice on how to maximise your deductions on investment properties? Contact our team at Little today.