Most investors are aware costs such as interest, property management fees and ongoing maintenance are all tax deductible; however, with interest rates being so low, the tax deduction associated with depreciation could potentially be one of the biggest claimable deduction for some.
Here is our rough guide to depreciation and why you shouldn't ignore it.
What is depreciation?
Like a car, there are certain things in your property which will lose value over time because they become worn out and eventually need to be replaced. This also includes what is known as 'plant and equipment' such as light fittings, air-conditioners and carpet.
Why is it important?
Well for starters, it puts money back into your pocket! As you can claim tax on the depreciation value, it can be used to reduce your tax payable! For those with a negatively-geared property, it can also be used to effectively reduce the loss.
Seasoned investors even factor depreciation in their purchase strategy, potentially making a new property affordable.
How is it worked out?
Depreciation is calculated and projected (or forecasted) over several years, and it's split into two types.
- Capital works deductions
This is the construction costs to the building itself. For example, items like brickwork and concrete. The length of time the ATO says a building lasts before it needs replacing is 40 years, so this is the length of time the depreciation is calculated.
- Depreciating assets
These are assets that have a limited effective life, such as the items mentioned earlier, carpet, air conditioners etc. It might even include ovens, microwaves, and other white goods if the landlord has bought them.
Like the items listed in the capital works, the ATO lists all items you can claim and for how long the item lasts (known as 'the effective life') before it needs replacing.
For example, carpet has an estimated life of 10 years, while a kitchen stove has an effective life of 12 years.
How much can I get?
The amount will obviously vary from property to property, but there is the potential to claim back several thousand, and in some cases, tens of thousands.
For instance, using the example of capital works deductions, a new building that cost $200,000 to build, you could potentially make a $5,000 tax claim each year for 40 years (i.e. 2.5% per year).
How do I work it out?
Accountants are not qualified by the ATO to estimate construction costs so the best way to do this is to arrange a qualified quantity surveyor to inspect your property. They will then prepare a Tax Depreciation Schedule for your accountant, who then includes this in your tax return.
Does it cost?
Yes, you will have to pay the surveyor to inspect your property and prepare a report, but while there is a cost associated with this, it is usually a one-off cost, and it is also usually tax deductible.
Furthermore, the cost of a surveyor usually easily outweighs the benefits you will receive as a result of the depreciation tax deductions.
What if I make improvements to the property?
If you do make improvements to the property in the past financial year, it's worth contacting your quantity surveyor to see if your depreciation schedule should be updated.
There is a difference between a repair and a capital works (eg major renovation such as the addition of a room), as this will affect the claim. New equipment, such as a new air conditioning unit may well need to be factored into the depreciation schedule.
The cost of repairs may be claimed in full in the same financial year they are completed, but best seek advice to ensure the deductions are claimed correctly.
For more information, visit the ATO website and talk to your accountant.
If you have any queries at all about property investment and want to know more about how our property management services can assist you, give us a call on 07 5479 0868 or send us an email to rentmyproperty@century21.com.aiu.