Tax allowances often make investment properties profitable, and depreciation is one of the best allowances out there – writes The Successful Investor’s Michael Sloan.
For the average Australian, tax allowances make property investing affordable.
Depreciation on investment property is an essential tax allowance to claim. In this article, we’ll look at depreciation on new properties.
If you’ve bought an existing property, take a look at this article: Claim depreciation on an older investment property.
(Please note that, as announced in the May 2017 Budget, from 1 July 2017, property investors can only claim tax depreciation for plant and equipment, if you actually bought it yourself; or it was included in the new property.)
WHAT IS DEPRECIATION?
Depreciation is how much the Australian Tax Office (ATO) says assets decrease in value as they age. For example, on a $2,000 desktop computer they allow four years. This gives you a $500 tax deduction, per year, over four years.
HOW PROPERTY INVESTORS CLAIM DEPRECIATION
Property investors claim depreciation in two ways:
1. Capital works deductions
This is the cost of building the investment property (i.e. the construction costs). This depreciation is spread over 40 years – the length of time the ATO says a building lasts before it needs replacing. For instance, on a new building that cost $200,000 to build, you could make a $5,000 tax claim each year for 40 years (i.e. 2.5% per year).
2. Depreciating assets
The ATO’s definition of depreciating assets is “… an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. Depreciating assets include such items as computers, electric tools, furniture and motor vehicles.”
For property investors, this might include light fittings, stoves, carpets and even the humble rubbish bin.
The ATO lists all items you can claim — and for how long. Known as ‘the effective life’, this is how long they say an asset lasts before it needs replacement.
For example, carpet has an estimated life of 10 years, a kitchen stove 12 years, and that bin will last a decade.
HOW DO I CLAIM FOR DEPRECIATING ASSETS?
You have two choices when claiming this tax allowance:
1. Prime cost method
This gives you an equal tax deduction each year over the item’s effective life.
2. Diminishing value method
This gives you higher claims in the first years of the item’s effective life, and smaller claims later on.
Most investors opt for diminishing value, as it will give you a higher depreciation rate earlier. Your accountant will be able to advise which method is best for you.
HOW DO YOU CLAIM DEPRECIATION?
It’s a good idea to engage a quantity surveyor. Quantity surveyors are experts at assessing the value of construction work.
They’ll be able to provide you with a report on the rate of depreciation claimable on your property, and when you can claim it. You can then send the report to your accountant, who in turn will claim it on your tax return.
Some quantity surveyors are better than others so look for a specialist firm who’ll put the time in to visit your property.
For info on what you can claim, check out the Australian Tax Office’s (ATO), Rental Property 2014 (PDF, 1.26MB).