Tax Depreciation with an Investment Property

Depreciation is a complex area, however all property investors should have grasp on some of the subtleties surrounding it and how they can benefit from these. Depreciation is an accounting term and describes the general wear and tear of an asset, which occurs over the time that you own it (also called its ‘useful life’). Typically a building won’t appreciate in value, it is the underlying land value that does (there are some edge cases where this doesn’t always hold true).

The government allows investors to claim depreciation on some property assets and the building itself over their useful life. The ATO provides a breakdown of available deductions by building depreciation (Capital Works deductions) and items depreciation (Capital Allowance deductions) as well as their prescribed depreciation rates depending on the useful life of the asset and method chosen to calculate the depreciation (e.g. a hot water system is 8 years per ATO). There can sometimes be confusion as to what is classified as ‘Asset’ or ‘Building’ related (ATO asset list has over 1,500 items), but for example the below table will provide a general idea.

Building

Asset

Driveway Air conditioning units
Paths Rainwater tanks
Electrical wiring Hot water systems
Wash Basins/Baths Stoves
Electrical wiring/Plumbing Television Antennas
Built in Kitchen cupboards Above ground Pool
Sky Lights Furniture

There are two methods to calculate the value of depreciation on an asset that are acceptable to the ATO:

Prime Cost – The tax rate for the Prime Cost method is calculated by evenly distributing the tax over an asset’s useful life in years. So the prime cost depreciation rate for an asset expected to last 5 years is 20%. The assumption with this method is that an assets wear and tear is constant over its useful life.

Diminishing Value – The tax rate for the diminishing value method is calculated by dividing 150% by an asset’s useful life in years. So the diminishing value depreciation rate for an asset expected to last 5 years is 30%. The assumption with this method is that an assets wear and tear is greater in the early years of use (which results in higher depreciation values).

For example you bought $1,000 worth of furniture with an ATO prescribed useful life of 5 years the depreciation values in each year using the differing methods would be as below:

Year

Prime Cost

Diminishing Value

1

$1,000 x 20% = $200 $1,000 x 30% = $300

2

$1,000 x 20% = $200 ($1,000 – $300) x 30% = $210

3

$1,000 x 20% = $200 ($1,000 – ($300+$210)) x 30% = $147

4

$1,000 x 20% = $200 ($1,000 – ($300+$210+$147)) x 30% = $102.90

5

$1,000 x 20% = $200 ($1,000 – ($300+$210+$147+$102.9)) x 30% = $72.03

No further depreciation Continues to depreciate

Calculating the value of depreciation on Building (Capital Works) which includes construction, extensions etc is calculated at a flat rate of 2.5% for a 40 years. By way of example any new property constructed is eligible to claim depreciation at 2.5% for a 40-year term. If you were to purchase a property that is 10 years old you would only be entitled to claim the remaining 30 years of the 40 year term.

Some tips to consider when looking at depreciation:

– Properties built prior to when the building allowance was brought in (1985) are still able to be depreciated.
– Typically the higher the building the higher the depreciation available to it. This is the higher allowances for plant and equipment that taller buildings attract (e.g. elevator), where apartment owners can claim a portion of amenities provided (pool, gym etc).
– Individual items under $300 can be written off immediately. This also applies to shared items where your portion is under $300.
– By furnishing your property you can increase your depreciation deductions and also increase your rental income (Need to do the numbers and ensure you have the right rental pool looking for furnished buildings).

I highly advise seeking professional advice from an experienced quantity surveyor who has extensive knowledge of construction and allowable deductions in line with ATO requirements. They will be able to provide you with a Tax Depreciation Schedule for a property which estimates how much wear and tear is left, as well as the depreciable amount for that year.

About the Author: David is an avid web, finance and property geek who decided to combine these interests and found BAG in his spare time. If you have thoughts, issues or questions you can find him at LinkedIn, Google+ or alternatively drop him an email david at buyersagentguide.com.au

Leave a Reply