10 cash flow boosting facts about property depreciation
Adam here. While I’m a big advocate of “DIY” property management, I learnt the hard way that depreciation is something best left to the experts.
I missed out on a lot of deductions trying to do it all myself the first time around, and I want you to learn from my mistakes.
No investor purchases an investment property without the thought in mind that it will help to boost their income and provide them with additional cash.
Yet every year when investor’s perform their annual income tax returns, thousands of dollars from depreciation deductions that could help them to reduce their tax and improve their cash flow from property go unclaimed.
In fact, a recent comparison completed by BMT Tax Depreciation found the amount the Australian Taxation Office (ATO) reported 2.5 million property investors claimed on average in the 2011-2012 income year with the average deductions found by BMT for their clients suggested that investors fall short of claiming approximately $4,182 in deductions.
In their report, the ATO advised just over one million investors claimed an average of $2,029 for capital works deductions, while just over 1.7 million investors claimed an average deduction of $1,139 for plant and equipment items. Making the total average depreciation claim made by property investors in the 2011-2012 income year $3,168.
By comparison, the data from schedules for thousands of BMT Tax Depreciation clients suggested that the average claim should be around $10,100 in the first full financial year of ownership and $7,350 per year on average over the first ten years of owning an investment property.
As you can see, depreciation deductions can represent a substantial amount of money for an investor. So what is property depreciation and how can you ensure your claim is maximised? To answer both of these questions and more, we’ve put together a guide of the top ten depreciation facts to be aware of and included some examples in these points which show how claiming depreciation will make a difference for any property investor.
1. What is property depreciation?
Depreciation is a non-cash deduction where the Australian Taxation Office (ATO) allows the owner or owners of an investment property to claim a deduction due to the wear and tear of a building structure (capital works deduction) and its fixtures (plant and equipment depreciation) over time. It is described as a non-cash deduction because an investor does not need to spend any money to be able to claim it.
Capital works deductions apply to the structural element of a building such as bricks, mortar, walls, flooring and wiring and are based on the historical cost of the building. These deductions can only be claimed on residential buildings in which construction commenced after the 15th September 1987.
Plant and equipment assets are items which can be easily removed from the property, as opposed to items that are permanently fixed to the structure. These assets depreciate based on their effective life as set by the ATO.
2. Can I get an idea of what depreciation deductions will become available prior to purchase?
Before any investor buys an investment property it is essential they do some research. Savvy investors will usually consider the potential rental return of the property, the property’s location and the historical growth of property prices within the area.
Finding out the tax deductible costs will help an investor to get a complete picture of what their future position will be once the property has been purchased and rented. This information can also assist investor’s in their purchase decisions as the investor will have a better perspective on whether the property is in their budget and affordable.
BMT Tax Depreciation offer investors a handy tax depreciation calculator (watch the video below) to find out what depreciation is available on any property they are considering purchasing.
3. Does the age of the property affect deductions?
Many investors falsely assume that because their property is old they are no longer entitled to claim depreciation. This is in part due to restrictions the ATO place on claims for the capital works component of the property.
Although legislation states that only the owners of properties in which construction commenced after the 15th of September 1987 can claim capital works allowances, these restrictions do not apply to plant and equipment assets. It is the condition and the quality of each plant and equipment item which contributes to their depreciable amount.
Often older properties have also been renovated or updated over time. Even if these renovations or improvements have been completed by a previous owner of the property, the new owner may be entitled to claim deductions so long as they were completed within the ATO legislated dates.
The table below shows how the age of the property affects the deductions found for a property with a similar purchase price of $460,000.
As you can see, although the owner of a newer property constructed after 2012 will receive much higher deductions, the owner of an older property constructed prior to 1974 will still receive a substantial first year depreciation deduction of $7,127.
4. What is involved in claiming depreciation?
Claiming depreciation is a relatively simple process. Property investors should speak with a specialist Quantity Surveyor like BMT Tax Depreciation to arrange a tax depreciation schedule for the property.
Quantity Surveyors are recognised by the ATO under tax legislation TR97/25 as one of the few professions with the appropriate skills necessary to estimate construction costs for depreciation purposes. As part of the process of organising a depreciation schedule a site inspection of the property is conducted to take measurements and take photographic records of any of the assets contained within the property.
Specialist Quantity Surveyors are also affiliated with industry regulating bodies and gain access to the latest information and resources through their accreditations. This information, combined with the information gathered during the site inspection of the property, enables them to provide an accurate and detailed depreciation schedule which shows the deductions an investor can claim for the life of the property (forty years).
The depreciation schedule can then be used by the owner’s nominated Accountant to make their claim when they perform their annual income tax assessment.
5. What does the property owner need to provide?
A specialist Quantity Surveyor will ask investors to provide some basic information about their property in order to produce a tax depreciation schedule. The information required includes:
- The date of settlement
- The purchase price
- The details of your Property Manager or tenant to arrange access to the property in order to perform a site inspection
- Any information you have available regarding improvements or additions that have been made to the property, including dates and actual costs (where available)
- The date the property became available for income producing purposes
6. How does depreciation improve my cash flow?
For an investor experiencing negative cash flow on their property, depreciation can be the key to turning their situation into a more positive scenario.
The following scenario shows how one investor’s cash flow with and without a depreciation claim.
The investor owns a ten year old house purchased for $560,000 with a rental income of $530 per week and a total income of $27,560 per annum. Expenses for their property such as interest, rates and management fees totalled to $36,060. After conducting the relevant research and site inspection, BMT Tax Depreciation found the investor would be entitled to claim a depreciation deduction of $13,500 in the first full financial year of owning the property.
This investor used property depreciation to turn their negative cash flow position into a positive one. Without claiming depreciation, the property investor would experience a loss of $103 per week during the first year of owning the property. By claiming depreciation, the weekly cost was reduced to $7, saving the owner of the property $96 per week or $4,992 in the first year of ownership.
7. What is pooling?
Low-value pooling is essentially a legislated method of depreciating plant items within an income property at a higher rate to maximise depreciation deductions. Two categories of depreciating assets can be allocated into a low-value pool and are claimed at a higher tax rate to maximise deductions. These are low-cost and low-value assets.
A low-cost asset is a depreciable asset that has a cost of less than $1,000 in the year of acquisition. A low-value asset is a depreciable asset that has an un-deducted value of less than $1,000. That is, the cost of an asset is greater that $1,000 in the year of acquisition but the value remaining after depreciating over time (opening value less deductions in year one less deductions in year two, etc) is less than $1,000. Assets meeting both these classifications can be placed in a pool and depreciation at an accelerated rate.
8. Which depreciation method should I choose to suit my investment strategy?
There are two methods used when depreciating the plant and equipment assets contained within an investment property. An investor can only choose one of these methods, so it is important to speak with your Accountant or a Financial Advisor for advice when selecting the best method to suit your investment strategy.
The two methods are the diminishing value and prime cost methods. Under the diminishing value method, the deduction is calculated as a percentage of the balance you have left to deduct while under the prime cost method, the deduction for each year is calculated as a percentage of the cost.
If you choose the diminishing value, you are claiming a greater portion of the assets costs in earlier years. This method may be more suited to someone who plans to only hold the property for a short period of time, someone who wants to build their investment portfolio quickly or who would like to save to budget for renovations. If you prefer to receive deductions at a more constant rate over time, then the prime cost method may be the better method for you.
9. What happens if I decide to renovate the property?
When renovation work has been completed to a property or is in the planning stages, it is essential to contact a specialist Quantity Surveyor and request a site inspection of the property. Additional deductions may be available for any capital improvements done to a property.
Often when renovations have been completed by a previous owner of the property, the additions may not be obvious. A site inspection of the property will allow a Quantity Surveyor to discover any work that has been completed, including non-visible assets like plumbing, water proofing and electrical wiring. The Quantity Surveyor will then estimate the deductions available from any assets or structural additions that have been made within the qualifying dates and calculate the depreciation accordingly.
If an owner is planning on doing any renovation work to their property, an inspection should be performed both before and after the renovation work is complete. The owner may be entitled to claim additional deductions for any remaining depreciable value of assets or structures removed from the property and written off in the year the items are removed.
10. What should be included in my depreciation schedule?
No two depreciation schedules provided by Quantity Surveying firms are alike. To ensure depreciation deductions are being maximised, it is important to check the depreciation schedule you request is comprehensive and includes the following:
- Both prime cost and diminishing value method deductions are shown for plant and equipment assets
- A comparative table of the two methods of depreciation is included
- A forty year projection that shows all of the deductions available for the life of the property
- Low-value and low-cost pooling are used to accelerate deductions
- The effective life of each asset is displayed and a total shown for the division 40 effective life and pooled assets
- A pro-rata calculation is used when a property is acquired part way through a financial year or rented for only a percentage of the year
- Percentage based grouping of assets which shows a calculation of all assets depreciated at the same percentage rate grouped and totaled
- In the relevant states where common property deductions apply for the owners of strata or community title complexes, items such as lifts and swimming pools are included in the depreciation schedule
- Split reports are available when a property is owned by more than one person, resulting in higher deductions earlier
- Excel and CSV formats are provided to Accountants for easy use with their software
If you would like to learn more about property depreciation, simply visit the BMT Tax Depreciation page for property investors by clicking here. You can also watch the below quick question and answer video.
Speak with one of the friendly staff at BMT Tax Depreciation on 1300 728 726.
Article provided by BMT Tax Depreciation.
Bradley Beer (B. Con. Mgt, AAIQS, MRICS) is the Managing Director of BMT Tax Depreciation.
Please contact 1300 728 726 or visit www.bmtqs.com.au for an Australia wide service.