PROPERTY DEPRECIATION 101
Contributor: Ridhwan Hannan, Senior Tax Advisor from OnePath Accountants
You may have heard the term, land appreciates while property depreciates. This implies that depreciation is a bad thing, when in fact depreciation is actually beneficial to your cash flow.
HOW DOES DEPRECIATION WORK?
Well, when your building or fittings lose some of their value, you can claim this against your taxable income, and get tax benefit for the loss in value.
If you bought your property well, you should have found the sweet spot. Ideally you have a property which is growing in overall market value, while also depreciating on the tax books and freeing up more after tax cash flow.
WHAT ITEMS DEPRECIATE?
There are two kinds of depreciation allowances available when it comes to property. Both these costs can be offset against your assessable income.
1. DEPRECIATION ON PLANT AND EQUIPMENT
Plant and Equipment refers to items within the building like ovens, dishwashers, carpet and blinds etc.
2. DEPRECIATION ON BUILDING ALLOWANCE
Building Allowance refers to construction costs of the building itself, such as concrete and brickwork etc.
FEDERAL BUDGET CHANGES TO DEPRECIATION
The 2017 federal budget announced changes to property depreciation. Changes were made to depreciation treatments on residential properties.
Investors can no longer claim depreciation on plant and equipment installed by a previous owner. Read more about the changes to property depreciation here.
DEPRECIATION CALCULATION METHODS
There are two ways to calculate depreciation, the best method varies by property and individual.
1. PRIME COST METHOD
This assumes that the asset experiences even wear and tear or loss of value over its lifetime. A constant rate is applied for each year of the assets effective life. Depreciation is more evenly spread out across the years.
2. DIMINISHING VALUE METHOD
This method assumes that an asset loss value quicker in the early years of its life. This method returns higher returns in the first few years, and progressively smaller returns over time.
To work out the deductions using the two methods you need the following information.
• ASSET COST – Initial purchase cost
• BASE VALUE – Initial purchase cost minus total of previous years deductions
• NUMBER OF DAYS HELD – In the current financial year
• EFFECTIVE LIFE – The ATO maintains a list of over 1,500 assets on its website.
For the Prime Cost Method, use the following calculation:
Asset Cost x Days Held/365 x 100% Effective Life
For the Diminishing Value Method, use the following calculation:
Base Value x Days Held/365 x 200% Effective Life
While the calculations above are a good ‘rule of thumb’, they only apply to assets bought after 2006.
Tax and depreciation can get complicated, for example depreciation on Building Allowance can only be claimed on properties purchased after 1987, for as long as the property is under 40 years of age.
With this in mind it’s best to consult your accountant. You don’t want to be doing any guesswork when it comes to the ATO.
You accountant will need to know the cost of all the depreciable items in your property. If you don’t know these then you need to get a qualified quantity surveyor to create a report for your property.
The ATO has specific rules about who is qualified to estimate construction costs of a building, stating, “Unless they are otherwise qualified, valuers, real estate agents, accountants and solicitors generally have neither the relevant qualifications nor experience to make such an estimate.”
A qualified quantity surveyor will physically inspect your property, itemize all depreciable assets along with their value and service life. They will provide an itemized report with a table stating each items depreciation over its life time.
At first, depreciation reports may seem costly however you only need to do them once per property. In addition, the cost of the service is usually tax deductible itself.
CAN I BACK CLAIM FOR PREVIOUS YEARS?
If you haven’t claimed any depreciation for your investment property until now, you may amend up to two years of tax returns to do so.
CAUTION, IT’S A DOUBLE EDGED SWORD
When you sell a property, the depreciation claimed to date has to be added back, and tax paid on it.
Make sure to get a clear understanding of what your actual financial position would be if you were to sell, hold or improve your property.
Be careful to when listening to tax advisors and make sure they have your best longterm interests in mind.
Ridhwan Hannan is a property investor and a Senior Tax Advisor from OnePath Accountants
You can contact Ridhwan at firstname.lastname@example.org or 1300 686 069