As long-time property investors and seasoned tax accountants, we often encounter new clients who have neither heard of depreciation nor ordered a depreciation report/schedule from a quantity surveyor ever, leading us to write this blog article.
What is depreciation?
First things first, what is depreciation?
Assets such as buildings, equipment, fixtures and fittings have limited effective useful lives. Therefore, they are expected to decline in value over the time that they are used. Property investors cannot deduct spending on capital assets immediately. Instead, they may claim the cost over time, reflecting the asset’s decline in value. This decline in value is known as depreciation.
2 main types of depreciation for investment properties:
There are 2 main types of depreciation for investment properties:
- Division 43 depreciation (capital works deduction or building depreciation) – this is a depreciation of the cost of the building structure over 40 years, or 2.5% per annum.
- Division 40 depreciation (capital allowance or plant & equipment depreciation) – this is a depreciation of the cost of equipment, fixtures and fittings over their useful lives which vary. For example, carpets may be depreciated over 10 years, cooktops over 12 years and gas ducted heating systems over 20 years.
How does depreciation benefit property investors?
Depreciation is a valuable tool that property investors can use to maximise their return on investment by reducing their taxes. It is not an actual loss as there have been no actual payments or outgoings incurred by the property investor. Instead, depreciation represents a loss on paper that is an allowable deduction.
Do depreciation deductions affect Capital Gains Taxes (CGT) for an investment property?
Yes and no. Not all depreciation claimed is deducted from the cost base of an investment property.
Only Division 43 depreciation (capital works deduction or building depreciation) reduces the cost base of an investment property. However, it is important to note that property investors would have claimed the full amount of annual Division 43 depreciation, but are effectively only taxed on half of the reduction in cost base due to the 50% CGT discount available if they have held the property for at least 12 months. (For simplicity of this article, let’s disregard the fact that the marginal tax rates may not be the same for annual rental income and CGT. Always seek specialist tax advice about your specific situation.)
Division 40 depreciation (capital allowance or plant & equipment depreciation) does not reduce the cost base of an investment property. Therefore, it will not affect CGT for the property.
Therefore, both types of depreciation make it worthwhile to claiming depreciation on investment properties.
How do 2017 depreciation legislation changes affect depreciation deductions for rental properties?
In May 2017, the Federal Government announced that individual investors of second-hand residential properties purchased after 7:30 pm on 9 May 2017 may no longer claim depreciation of second-hand residential property assets (Division 40 assets) as an annual tax deduction, with the exception of, any new assets installed and paid for after purchasing the investment property. Examples of such assets include replacement hot water systems, kitchen appliances, carpets, blinds, etc.
How do 2017 depreciation legislation changes affect capital gains taxes on rental properties?
Depreciation on any existing equipment, fixtures and fittings at the second-hand investment property purchased after 7:30 pm on 9 May 2017 can still be claimed as a CGT offset when the property sold. In other words, the deductions are not lost forever even though the property is purchased second-hand.
How to Determine Depreciation Deductions
Depreciation deductions are usually determined by quantity surveyors who are registered with the Tax Practitioners Board. A good quantity surveyor will inspect the property and draw up a detailed depreciation schedule which lists all depreciable items that are usually depreciated at different rates. This is a once-off expense gets you a detailed report which lists up to 40 years of depreciation deductions.
What Should I Do with my Depreciation Report?
Now that you have the depreciation report in hand (which often looks like pages and pages of numbers!), the next thing you should do is to provide it to your tax accountant (that’s us!) who will help you to select the relevant numbers to pop into your tax return for claiming your rental deductions. It’s that simple!
Division 40 of the ITAA Act 1997: Deductions for Capital Allowance
Division 43 of the ITAA Act 1997: Deductions for Capital Works
Disclaimer: This blog post has been simplified to explain depreciation and how it applies to residential property investors. This should not be construed as advice from Glint Accountants. Therefore, we encourage readers of this blog post to contact Glint Accountants for assistance with their specific circumstances.
Prefer to speak to someone about your investment property? Our director, Geraldine Lee, is a Fellow of CPA Australia with an investment property portfolio that includes residential and commercial properties interstate, locally and overseas. She is well-versed in the complexities of Australian taxation laws and how they apply to investment properties. Contact us at Glint Accountants to make an appointment to discuss taxes and deductions relating to your rental property, capital gains taxes, suitable structures for future property investments or even about re-financing your investment loan.