It’s almost that time of year again – yes, tax time! June 30 will be here before we know it and for all investors that means understanding how depreciation works and what can you claim in your tax return.
Despite being a relatively well-known part of buying a property, understanding and calculating the depreciation of your property is a topic few investors have a good grasp of. The problem with not understanding it correctly is that many people are failing to take full advantage of the depreciation deductions they are entitled to — which can be quite a lot of money in the long-term. So here is our simple guide to Property Depreciation 101.
Depreciation is a term used to describe the reduction in the value of an asset over time. If an asset is going up in value it is ‘appreciating’, and hence if it is going down in value it is ‘depreciating’. There are many reasons assets go up and down in value, but in the context of property and more specifically property tax considerations, depreciation means the reduction in the value of a property due to the natural wear and tear over time. Tax legislation recognises that certain assets depreciate over time due to fair wear and tear, and accordingly investors can claim this reduction in value in their tax returns.
Property depreciation is interesting in that it is considered a “non-cash deduction”, meaning you don’t have to pay for it on an ongoing basis. The deductions are built into the purchase price of the property itself. This is different to all other deductions like interest levies, which are paid on an ongoing basis.
There are two categories that investors can claim the depreciation of their property: Division 43 Capital Works Allowance and Division 40 Plants and Equipment. This essentially means that you can claim both the natural decline in the buildings structure and of any items considered permanently attached/fixed to the property, and the decline in value in plant and equipment assets found within it (ie. ovens, dishwashers, carpets, etc).
I am sure originally we may all have been able to form a reasonable assessment of how much each asset had depreciated over the past 12 months, but as I am sure you can appreciate this wouldn’t have worked successfully for long. So the tax office implemented scales which apply to each asset type which determines what can be claimed each year.
Technically, you are allowed to claim depreciation on any property — it just depends which category(s) you should use. If your property was built after July 1985, you are able to claim both the Division 43 and Division 40 deductions. Any property built before July 1985 can only claim depreciation on Plant and Equipment.
You can still claim if you have renovated your property. If you have renovated, you need to know exactly how much has been spent as providing this information is an obligation according to the ATO. If the previous owner renovated or for some reason the cost of renovation are unknown, a quantity surveyor is able to make an estimation on deductions.
Owners of second-hand property where contracts were exchanged after 7:30pm on the 9th of May 2017 are not able to claim depreciation on existing plant and equipment.
As we have identified above, the tax office publishes scales that can be applied to asset classes that determine what can be claimed as depreciation. This may seem quite straight forward, but in practice the process of identifying assets and classifying them is quite complicated. Industry professionals called Quantity Surveyors are specialists that do this specific job. The process of accessing the depreciation on a building can be a very complex process. Imagine for a moment what assets exist in a new residential tower for example. Think of all the air conditioning units, taps, lifts, security systems, security video, car park entrance swabs, fire pumps, automatic garage doors, and so on. The list is huge, and quite often each has a different classification for depreciation purposes.
The goods news is that quite commonly when you purchase a new apartment an assessment may be provided by the Developer by a quantity surveyor they have retained. This will help immensely in preparing your tax return. If you have done extensive renovations yourself then hopefully you have retained extensive records which will help. It is important to note that you must use a quantity surveyor to estimate construction costs when those costs are unknown — unless your property was built prior to 1985. The ATO requires the use of a quantity surveyor because the work is so specialised, according to Terry Aulich, Chief Executive Officer of the Australian Institute of Quantity Surveyors (AIQS).
“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,” says Mr. Aulich.
“One doesn’t want to rely on best guesses when dealing with the ATO – especially when there is professional help available.”
It’s important to note that you do have to get your accountant involved if you want to make a claim on previous tax returns. Your accountant can amend your previous tax returns as far back as two years (there are some exceptions). If you want to do this, get into contact with your accountant or the ATO to get better clarification.
Given that an inspection of the property is required under the AIQS code to satisfy the ATO requirements, you should begin planning for a day that will suit you (and your tenants). The best time to get a quantity surveyor to inspect your property is immediately after settlement and hopefully just before the tenant has moved in.
After you’ve booked an inspection in, the surveyor will come to your property and begin noting and photographing all depreciable items. This will ensure that you get all deductions you are entitled to, and that you have evidence in the event of the audit.
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.
Some 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. You have nothing to lose — especially considering the fact that quantity surveyor fees are 100% tax deductible.
Your depreciation schedule will take approximately 2-3 weeks to complete, as long as the quantity surveyor can inspect your property without delay.
It’s always important to ensure that you’re on top of every aspect of owning an investment property. Even if you think you have a good understanding of how property depreciation works, make sure you talk to your accountant and any relevant parties before deciding on a path of action to ensure you do what is best for you and your finances.