How To Claim Depreciation On Investment Property?
Depreciation is something that will help your bottom line come tax time.
Just as you can claim wear and tear on a car purchased for income-producing purposes, you can also claim the depreciation of your investment property against your taxable income.
Claiming depreciation on an investment property is a great way to minimise your tax and maximise your cash flow returns. However, it is important to claim depreciation on investment property correctly.
Claiming too little means you are missing out on tax-saving opportunities but claiming too much or claiming incorrectly could be seen as tax fraud and incur hefty fines. In this post, we want to walk you through how to claim depreciation on an investment property the smart way.
Seasoned property investors know all about this one. In fact, some will take depreciation into account before purchasing their next investment. But it’s not just for the pros. Anyone who purchases a property for income-producing purposes is entitled to depreciate the building and the items within it against their assessable income.
Seasoned property investors will take depreciation into account before purchasing their next investment.
But others are none the wiser, which means that every year, thousands of dollars go unclaimed.
To make substantial savings, all property investors need to do is arrange a qualified quantity surveyor to inspect their home and prepare a report for their accountant.
Klear Picture Financial Advisors can help you with your Investment Depreciation needs.
What is property depreciation?
Property depreciation is a tax break that allows investors to offset their investment property’s decline in value from their taxable income. Australian law allows investors to claim tax deductions on both the decline in value of the building’s structure and items considered permanently fixed to the property and the decline in value of plant and equipment assets found within it (think ovens, dishwashers, carpets and blinds). Not only does it help you pay less tax, but it’s also a “non-cash deduction”, which means that you don’t have to pay for it on an ongoing basis; the deductions are built into the purchase price of your property. All other deductions, such as interest levies, will hurt your hip pocket on an ongoing basis.
Methods of calculating depreciation
There are two accepted methods of calculating your depreciation claim.
The Diminishing Value Method is where the claim reduces by a particular percentage each year. As a result you can claim more in the first year and less in later years. This is because items depreciate quickly when they are new, and slowly as they become older.
The Prime Cost Method is a fixed claim amount calculated as a percentage of the items original value or cost. Therefore your claim is the same each year for the life of the item.
Talk to your accountant or quantity surveyor about the two methods listed above and which will be applicable for the claims relating to your investment property.
What Depreciation Can I Claim On My Investment Property?
There are two types of depreciation you can claim on an investment property:
Construction costs to the building itself. Items like brickwork or concrete. The depreciation claim for plant, equipment and buildings is often overlooked. You are normally allowed to claim a small percentage of the cost of the building and fixed structures on the property over time.
Usually, the rate is 2.5% from the time the property is built, the total claim is limited to the cost of construction and you need to get a quantity surveyor to do the figures for you.
That might sound like too much of a hassle for a small result but think of this. If you bought a house today for $600,000 and that house cost $250,000 to build in 2000, then you could potentially claim an extra $6,250 against the rental income every year until 2040.
What if the house were instead an off-the-plan, newly built apartment? If it cost you $600,000 today with total building costs of $400,000 – then there are some big claims you could make of $10,000 per year.
Claiming building depreciation can be difficult because there are so many varying factors involved.
As depreciation has been introduced in Australia over time properties built during different time periods need to be claimed differently. There is no one set approach for all properties.
Before claiming building depreciation you need to know:
Date construction began
Depreciation percentages are calculated based off when the construction began on the property. Properties constructed in different time periods can claim depreciation differently.
Date construction ended
While rates of depreciation are based off the date construction commenced you cannot begin claiming depreciation until after construction ended. So this is an important date to know.
Cost of construction
This is not the cost to purchase the property or the value of the property. This is the actual cost of construction to build the property at the time of construction.
A quantity surveyor can estimate the cost of construction for taxation purposes if you do not know the cost of the construction
The type of construction
- Was it a residential house, residential townhouse, residential apartment, commercial property etc?
- Who carried out the construction work
- Was it an owner, was it a builder, was it a developer?
A quantity surveyor can help you identify any information you don’t have or are unsure about. They will then create a depreciation schedule for the building portion of your claim for you. This is the easiest way to do it if you don’t want to calculate it yourself.
Claiming Structural Improvement
You can also depreciate the cost of structural improvements (to residential property) if the construction began after 26th Feb 1992.
Remember, depreciation law has been introduced over time, that is why there are all these differing dates and why it can be so confusing.
Plant and Equipment
Item within the building such as carpets, light fitting, blinds or curtains, ovens, dishwashers etc. Believe it or not but garden plants are rarely claimable.
In order to correctly claim depreciation on your property, you need to have what is known as “a depreciation schedule” written up. This is the report that states all your claimable depreciation for tax purposes.
If you thought building depreciation was confusing wait until you try and work out your plant and equipment depreciation.
First The Good News
The good news is that almost all houses (even really old ones built before 1979) can claim depreciation on plant and equipment.
Many items that you need in your residential property (eg. Blinds, carpets) can be depreciated over time, giving us a tax saving.
Now The Bad News
According to tax law, the commissioner makes reviews and determines the effective life of claimable items, and this may change over time.
This means you need to work out which tax ruling, or which schedule accompanying the relevant tax ruling to use for each different item’s effective.
Because an oven might not last as long as the carpet, and the blinds might not last as long as the oven, everything needs to be claimed at its own rate of depreciation.
Back To The Good News – Immediately Claimable Items
There are some items you can claim the full amount on instantly, so you don’t have to depreciate it.
Items under $300 – Let’s say you buy a new microwave for $200 for your tenant. You don’t have to depreciate it over time you can claim the full $200 in the tax year you bought it.
NOTE: Items in a set (eg. Dining chairs) are counted as a single asset. So even though 4 dining chairs might only cost $90 each they will need to be depreciated because the total cost of the set is $360.
Items under $1,000 – Items under $1,000 in value can be added to what is known as the “low-value pool”. This is a collection of items all with values under $1,000.
Anything added to the pool gets depreciated at a diminishing rate of 18.75% in the year that it is added. After the first year, an item is added to the pool it is depreciated at a diminishing rate of 37.5% for its effective lifetime.
This saves you having to separately calculate the depreciation of every single little asset you have in the property. It makes calculations much easier.
Everything over $1,000 – Everything over $1,000 needs to have its depreciation calculated based on its effective life. A calculation is done (based off its effective life) and the item is generally claimed at a diminishing rate of return.
It is calculated separated until the item falls below $1,000 in value and then it is generally added to the “low-value pool”.
Is my property too old to claim depreciation?
The simple answer is no. If your residential property was built after July 1985, you will be able to claim both Building Allowance and Plant and Equipment. If construction on your property commenced prior to this date, you can only claim depreciation on Plant and Equipment. But it will still be worthwhile.
Commercial and industrial properties are subject to varying cut-off dates.
Klear Picture Property Advisors can help you with all your investment property needs.
Shouldn’t my accountant prepare this report?
If your residential property was built after 1985, your accountant is not allowed to estimate the construction costs, nor are real estate agents, valuers or solicitors.
According to Tax Ruling 97/25, issued by the Australian Taxation Office (ATO), quantity surveyors are appropriately qualified to estimate the construction costs, when those costs are unknown.
According to Terry Aulich, Chief Executive Officer of the Australian Institute of Quantity Surveyors (AIQS), while accountants can offer general advice on other aspects of tax depreciation, construction costs and property depreciation are domains that require highly technical expertise.
Quantity surveyors are specialists in the accurate measurement of construction costs with a view to maximising a client’s financial position in relation to their property assets. Only a fully-qualified quantity surveyor brings the appropriate education, experience and training to provide reliable figures upon which to base a property tax depreciation schedule.
One doesn’t want to rely on best guesses when dealing with the ATO – especially when there is professional help available.
Terry also suggests that clients should check the credentials of anyone claiming to be a quantity surveyor. He recommends that the first question clients should ask their quantity surveyor is whether they are a member of the AIQS, as membership indicates that a quantity surveyor has completed an accredited qualification.
My property is renovated. Can I still claim?
Yes, but you will need to know how much you spent on renovations. Providing this information is an ATO obligation.
If the previous owner completed the renovations, you are still entitled to claim depreciation.
In either case, where the cost of renovation is unknown, a quantity surveyor has been identified by the ATO as appropriately qualified to make that estimation.
How much will my depreciation schedule cost?
The cost of preparing a tax depreciation schedule varies according to a number of factors, including the type of property you’ve purchased, its location and size.
Most of the leading quantity surveyors offer a money-back guarantee to save you twice your fee in the first year, or they give you the report for free.
So you have absolutely nothing to lose – and many deductions to gain.
To sweeten the deal further, quantity surveyor fees are 100% tax-deductible.
How much will I save?
Each property is different and many factors must be considered when preparing a property depreciation schedule. There are several depreciation calculators on the market, many of which can be found easily through a Google search for “depreciation calculator”.
Don’t pay for a property depreciation estimate; in my opinion, the best ones are free.
Klear Picture are your reliable Investment Property Advisors in Melbourne.
How Much Depreciation Will I Be Able To Claim?
Depreciation varies from property to property. Generally speaking the newer the property the higher the claimable depreciation will be.
In older properties, you may still be able to claim a few thousand dollars in depreciation of your plant and equipment and in newer properties where everything is brand new you could likely gain tens of thousands of dollars in claimable depreciation.
Is Claiming Depreciation Worth It?
Now that you understand depreciation it is important to ask the question “Is claiming depreciation even worth it?”
Let’s me show you some examples and then you can be the judge.
If you are in the 30% tax bracket and can only claim $3,000 in depreciation this will likely save you $900 in tax.
$3,000 x 30% = $900
If you are in the 30% tax bracket and can claim $15,000 in depreciation then this could possibly save you $4,500 in tax
$15,000 x 30% – $4,500
So yes, in most cases claiming depreciation is well worth the effort.