Property depreciation is a non-cash tax deduction available to the owners of income-producing properties. It is one of the few tax benefits that Perth tax accountants can discuss with their clients, and it does not require the ultimate cash payment to enjoy.
As a building ages, items wear out—they depreciate. The Australian Taxation Office allows property owners to claim this depreciation as a tax deduction.
The Australian Taxation Office (ATO) clearly defines two types of depreciation allowances available for property investors:
- Division 43 capital works allowance
- Division 40 plant and equipment depreciation
The capital works allowance refers to what an investor can claim for the wear and tear on the property’s structure. This includes any structural improvements that may have been made during a renovation.
Plant and equipment depreciation, on the other hand, refers to the deductions an investor can claim for the wear and tear on the easily removable fixtures and fittings within the property.
Investors often wonder about the depreciation differences between older and new properties. The simple answer is that the owners of newer properties will receive higher depreciation deductions. However, new and old investment properties can attract depreciation deductions for their owners.
As a commercial property investor, the tax depreciation rates do not have to be the same as your reporting depreciation rates. If you use the same tax rates as your reporting rate, the depreciation makes your business reports useless.
Capital works deductions are calculated at 2.5 per cent of a building’s structural costs and can be claimed annually for forty years. Construction costs generally increase over time, increasing write-off deductions on new buildings.
Owners of older properties can claim the residual value of the building up to forty years from construction. For example, if an investment property is five years old, the owner will have thirty-five years left of capital works deductions to claim.
Capital works deductions are governed by the date that construction began. Any property constructed after the 15th of September 1987 attracts capital works deductions. Suppose your property was built before that date. In that case, you should still contact BMT, as you can claim for any renovations the property has undergone, including those the previous owner did.
Residential property owner changes 2017
Under legislation enacted on Wednesday, November 15th, 2017, owners of second-hand residential properties (with contracts exchanged after 7:30 p.m. on May 9th, 2017) can no longer claim depreciation on existing plant and equipment assets, such as air conditioning units, solar panels, or carpets. However, these property owners can still claim depreciation on any plant and equipment assets they purchase for the property.
No changes have been made to capital works deductions, typically representing 85% to 90% of a depreciation claim. This allows Australian property investors to continue claiming substantial deductions.
Furthermore, if you purchased your property before 7:30 p.m. on May 9, 2017, you could continue to claim deductions as per the previous rules.
What happens when you sell the property?
The sale of the property reverses your previously claimed tax deductions. However, there is still a significant benefit as you have the time value of money at play and enjoy the 50% Capital Gains Tax Discount on sale.
Let’s assume that you purchase the property for $500,000 and own it for 10 years, claiming $5,000 of depreciation yearly and that your taxation rate is 32.5%.
By claiming $5,000 as a tax deduction each year, you will save $1,600 in tax; over 10 years, this is a tax saving of $16,000.
If you sell the property, the tax benefits of the capital works are reversed. The $50,000 of tax deductions (10 years @ $5,000) reduce your tax purchase price of the property from $500,000 to $450,000.
For the sake of the example, we will assume you sold the property for exactly what you paid for it. This is to simplify the example without factoring in future capital growth.
As you have claimed depreciation, the adjusted cost base of the property is:
| Purchase price including stamp duty | 500,000 |
| Capital works allowance claimed | -50,000 |
| Cost base of the property | 450,000 |
| Property sale price (net of agents) | 500,000 |
| Less tax cost base | -450,000 |
| Taxable profit | 50,000 |
| Less 50% CGT Discount | -25,000 |
| Taxable income | 25,000 |
| Tax on sale (32%) | 8,000 |
| Tax saved during the years earlier | 16,000 |
| Net tax benefit of building allowance | 8,000 |
In this scenario, you still gain a significant tax benefit from the depreciation claimed over time. This could also contribute to paying off the loan, potentially saving interest in the long term. This is why claiming depreciation is always highly recommended.
These tax benefits also apply if you are adopting a rentvesting tax strategy.
Before selling a property, it’s crucial to assess the potential capital gains tax implications:
- Timing Considerations: It might be beneficial to hold onto the property until your taxable income is lower, reducing your capital gains tax liability.
- Low Interest Rates: With current low interest rates, holding costs are manageable and often less than the potential capital gains tax you might incur on selling.
- Avoid Unexpected Costs: Proper planning can help you avoid any unexpected tax burdens.
If you claim capital works deductions as a tax deduction, your liability to pay GST or adopt the GST margin scheme will be unaffected.
How do you know your construction cost?
Like any tax deduction, you’ll need to be able to provide evidence to make the claim. This can be retained and doesn’t need to be sent to the ATO with your online tax return. Should you be audited, you must provide evidence of the tax deduction.
You will need to provide evidence of the construction costs by either of the following:
- documents that show the construction costs, such as receipts or a builder’s summary of costs, or
- a report written by an appropriately qualified person such as a quantity surveyor or other independent qualified person.
The following items are not part of the construction cost:
- the purchase price of the building
- the purchase price of the land before construction
- the insured cost of the building
- the replacement cost of the building
- landscaping is generally not a construction cost and is treated differently than capital works
- In the case of an owner builder, your labour and expertise or any profit margin applied to the project.
How to get hold of the construction information you need
If you are involved in the construction, you should maintain records detailing the construction costs. If you have engaged a builder, ensure that they maintain and provide you with adequate records.
If you do not have records of the construction costs, you will need to obtain this information from either the previous owner or an appropriately qualified person.
This could be any of the following:
- quantity surveyor
- clerk of works, such as a project organiser for major building projects
- supervising architect who approves payments at project stages
- builder with experience estimating construction costs of similar building projects.
You can claim a deduction for the costs of obtaining this information from an appropriately qualified person in the income year you pay it.
Capital allowance schedules and depreciation
If you do not have construction costs, a quantity surveyor report can also include a schedule of depreciable assets (capital allowances). You can claim a separate tax deduction for the decline in value of depreciating assets in a rental property:
- if you bought the rental property before 7.30 pm (AEST) on 9 May 2017
- if the depreciating asset is brand new, you purchased it after 7.30pm (AEST) on 9 May 2017 whether you bought this as part of your brand-new property or, you subsequently bought it for your existing rental property
- for property purchased on or after 7.30 pm (AEST) on 9 May 2017 to provide residential accommodation, the property has to be brand new or substantially renovated to claim a deduction. Also, you can only claim a tax deduction for capital allowances if no one previously claimed any depreciation deductions on the asset, and
- either no one lived in the property when you acquired it, or
- if anyone lived in the property after it was built or renovated, you acquired it within six months of the property being built or remodelled,
- the property does not provide residential accommodation, or
- the asset is used in carrying on a business or
- the entity claiming depreciation is a:
- corporate tax entity
- superannuation plan other than a self-managed superannuation fund
- public unit trust
- managed investment trust
- unit trust or partnership whose members are any of the entities in this dot-point.
A final word
The tax benefits of building allowances and capital works tax deductions are commonly known. However, rarely, those tax benefits are properly implemented and recorded in a tax return so that capital works tax deductions are used and enjoyed in practice.
It is important to use a quality tax advisory practice, with independence and no connections to property agencies or banks, to understand the after-tax cost and benefit of making a major investment.
So, if you have a significant mature property development that needs careful management for your family and your business Westcourt is a natural choice – why not give us a call?
