About Tax Depreciation

TAX DEPRECIATION

Progressively during the 1980s the Australian Government introduced legislation enabling investment property owners to claim tax deductions for Tax Depreciation and Capital Allowances against their income producing properties.

Deductions for Tax Depreciation and Capital Allowances are divided into two categories; building depreciation and plant and equipment (asset) depreciation.

Building depreciation is a flat 2.5% deduction per annum of the original construction cost of the property for each year of ownership. This percentage can rise to 4% per annum depending on the type of property and when it was built.

Plant and equipment (asset) depreciation covers items such as carpets, blinds, curtains, appliances, hot water systems, etc which attract higher rates of depreciation. Legislation introduced by the Federal Government on 9 May 2017 limited plant and equipment depreciation to the investor who first acquired the item.

The Australian Taxation Office (ATO) acknowledges that the estimation of the original construction cost, that forms the basis of a Tax Depreciation and Capital Allowances Schedule, requires an “appropriately qualified” professional educated and experienced in the skill of construction cost estimating.

The ATO Legislation recognises that Quantity Surveyors are appropriately qualified professionals. It is important to note that ATO Legislation also notes that property valuers, real estate agents and accountants “generally have neither the relevant qualifications nor the experience to make such an estimate.”

The Tax Depreciation Company are specialists in Tax Depreciation and Capital Allowances. We will personally inspect your property, record all the depreciable assets contained therein, prepare an estimate of the original construction cost and present all this in a fully legible and easy to understand Schedule outlining all your depreciation entitlements.

There are two major components of an investment property depreciation calculation – the Capital Works Allowance and the Depreciating Assets within the property. The ATO also refers to these respectively as Division 43 and Division 40.

The Capital Works (Division 43) allowance is the deduction available for the building’s structure, along with fixed assets ie anything that is a permanent fixture or cannot be removed easily from the property.

Depreciating Assets (Division 40) are items commonly referred to as ‘plant and equipment’, or ‘plant and articles’. Loosely these assets are any item that can be picked up or easily removed from an investment property.

Below we explain each category in detail.

What are Capital Allowances? (Division 43)

The Capital Works allowance is the deduction available for a building’s structure and any fixed assets. In terms of the building structure this includes the actual brickwork, timber work, roof and footings. Fixed assets can loosely be described as items that can’t be easily removed from the property, such as built in cupboards or plumbing fittings.

The Capital Works Allowance is applicable to buildings built after 17 July 1985, and for most properties is set at a flat rate of 2.5% per annum, claimable over 40 years. Properties built until 15 September 1987 were able to be depreciated at 4% for 25 years.

You can only claim deductions for the period during the year that the property is rented or is available for rent. If you live in a property and intend to rent it out in future, investment property depreciation is not available to you until it is used for rent generation.

tax co table of claims

It is worth noting these dates prior to purchasing an investment property built around these eras. The construction date is a primary factor. Yet structural improvements can also be valuable in terms of depreciation of investment property allowances. Many older properties have had significant structural improvements such as new kitchens, bathrooms and outdoor renovations over the years. As long as they were completed after 1992, they are claimable under the Capital Works Allowance and could amount to significant tax deductions.

The building allowance is an historical allowance and utilises the actual construction cost at the date of construction. This can be obtained from the developers or builders. If this approach fails then it is an allowable practice to cost the construction by m2 at today’s cost and index it back to the actual date of construction.

There are specific costs not able to be claimed under the Capital Works Allowance. These include the costs associated with acquiring land, demolishing existing buildings, preparing a construction site prior to excavating (eg earthworks that are not integral to the installation or construction of a structure), and landscaping works. In addition, you cannot claim any value placed on your contribution as owner / builder to a project.

Evidence Required to Claim Construction Costs

The ATO requires the following types of information relating to the Capital Works Allowance:

· Commencement and finish dates of construction
· The type of construction
· Information on your builder
· The actual construction cost – by way of receipts or detailed listing of costs, or a report prepared by a qualified individual.

The ATO has specific rules about who is qualified to estimate construction costs of a building. The legislation specifically states that, “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.”

The following types of professionals are deemed by the ATO to be appropriately qualified to provide this information:

· A quantity surveyor
· A clerk of works (eg a project manager for a building project)
· A supervising architect who approves payments at each stage in a project
· A builder who is experienced in estimating construction costs of similar building projects.

What Are Depreciating Assets (Division 40)

Depreciating Assets can be described as any item that can be picked up or easily removed from a residential investment property. These items are commonly referred to as ‘plant and equipment’ or ‘plant and articles’. Legislation introduced by the Federal Government on 9 May 2017 limited plant and equipment depreciation to the investor who first acquired the item.

The ATO recognises these types of assets lose value over time and therefore investors should be able to claim a deduction. However, while the ATO uses a flat 2.5% for the Capital Works Allowance, it stipulates that Depreciating Assets lose value at varying rates, and so has defined an ‘Effective Life’ for over 1,500 assets to help investors calculate their investment property depreciation schedule.

Effective life of Depreciating Assets

The ATO gives Depreciating Assets an ‘Effective Life’ to determine how many years investors can depreciate them for. Effective Life is part of the calculation used to work out deductions for plant and furniture in an investment property.

The ATO says the Effective Life has regard for reasonable wear and tear, and is estimated to be the time taken from purchase (not from the time you start using it in your investment property), until the item is likely to be sold for no more than scrap value.

Some examples of common Depreciating Assets and their Effective Lives are as follows:

effective years depreciating asset table

Low Value Pool

Given there are so many types of Depreciating Assets, the ATO allows investors to group low cost assets together to make the process easier. Items costing between $300 and $1,000 fall into what is called a ‘Low Value Pool’ and attract a higher depreciation rate. In addition, items costing less than $300 can be written off in the year of expense.

PRIME COST OR DIMINISHING VALUE METHODS

The ATO allows two very different methods of calculating property tax depreciation deductions, the Diminishing Value Method and the Prime Cost Method. Most investors choose the Diminishing Value Method as it will return the greatest amount of deductions over the first few years of ownership. We use this method for all of our schedules as it is the most popular method among investors.

Short Term Letting

The building allowance is set at 2.5% for long – term letting, ( most properties) and 4% for short term letting. Short term letting covers hotels, motels and properties that qualify for short term letting.

To qualify for short term letting, properties must meet certain criteria set by the ATO. This includes a minimum of 11 units, must be certified as short term letting, have a permanent manager taking bookings and must have a public laundry.

Source: Australian Taxation Office