Property investors are often unaware that there are two different methods available to calculate the depreciation deductions for the plant and equipment items contained within their investment properties. Brad Beer tells us what they are.
 
Transcript:
 
Kevin:  Property investors are often unaware that there are two different methods available to calculate the depreciation deductions for the plant and equipment items contained with their investment properties, yet investors can only select one of these methods. Today I’m speaking to Brad Beer from BMT Tax Depreciation.
Brad, I wonder if you’d just give us a rundown of what the two depreciation methods are.
Brad:  Absolutely. There are two methods you get to claim these plant and equipment items under. One is called the diminishing value and the other one is called the prime cost method. Now, diminishing value is a higher percentage of claim, and it’s claimed each year based on the residual value, as in the amount diminishes, so you get more deductions up front and it diminishes down over time. The prime cost, the other method, is also known as the straight line method. It is a percentage of the value in the first year and the same amount every year until it runs out.
The diminishing value gets a bit more deductions in the early years; prime cost gets more even deductions over a longer period of time.
Kevin:  If an investor is only planning on holding a property for a short period of time, why would they choose the diminishing value?
Brad:  The decision between the two: when we prepare our reports, we actually give you both methods. Now someone who owns the property for a short period of time is probably trying to get the most out of it in that short period of time. Diminishing value gets a bit more deductions in those early years, which means more cash flow for the investor while they own that property.
Kevin:  Okay. What kinds of investors might choose prime cost?
Brad:  Someone who chooses prime cost might be someone who if in later years of owning this property – the third year, the fourth year – they expect to have salary increases and might be in a different tax bracket, then these deductions are more useful to them in a later period of time might choose that method. Or if you’re not in a very high tax bracket and these high deductions drag you below in tax brackets, then you might choose the prime cost method, as well. Because these deductions are only useful if you can actually claim them, and if you’re going to change tax brackets based on some of those, sometimes that prime cost might work better in your situation.
Kevin:  So explain how low value pooling works.
Brad:  Low value pooling is something that relates to items that have a lower value, and what you get to do is claim these things at 18.75% in the first year and 37.5% in the following years. Now they’re done under the diminishing value method: 37.5% is quite a high rate, so any of these low value things you get to claim a bit quicker and they are done under that diminishing value method. An investor might select this method because they actually want these deductions earlier in these years, and if that happens, then obviously more cash flow for the investor.
Kevin:  Brad, just in closing, can you give us an example of the differences in depreciation claimed using each of these methods over, say, a five-year break.
Brad:  Yes. I had a look at a couple of examples, and on a house that’s purchased for around about $500,000, I have the first five years of claims on a diminishing value at just over $50,000. Using the prime cost method, the same property came in at about $44,200. So there’s $6500 difference in deductions over the first five years of owning something like that.
A unit of similar value came out a little bit higher, about $8500 difference in deductions over those first five years, largely because a unit often has a bit more plant and equipment in it, so more of those things would have fallen into those diminishing value or prime cost methods.
It makes a few thousand dollars difference to deductions over the first five years of owning a property, which at your tax rate, potentially 30% or 50% of that comes back in cash. As investors, I think we’re always looking for cash now instead of later, so often the diminishing value will work better for most investors.
Kevin:  Yes, but as always, we suggest you take the advice of an accountant who specializes in this area. You can certainly talk to the team at BMT Tax Depreciation. Is that correct, Brad?
Brad:  Absolutely. We can give you the numbers, but we don’t know the rest of your financial situation and do the rest of your tax return. Your accountant will look at both methods that we give you, and they’ll be able to make your best recommendation.
Kevin:  Okay. First port of call will be Brad and the team, of course, at BMT Tax Depreciation. You can use the link on the home page at Real Estate Talk to contact them as well.
Brad, thanks for your time.
Brad:  Great. Thanks, Kevin.