First time property investors who have never claimed depreciation before often ask just how much of a difference depreciation deductions will make to their annual cash flow.
Depreciation can be quite a complex and daunting topic, but seeing a real world example really helps to explain how claims will make a difference for an investor.
Before we look at some numbers, it helps to have a basic understanding of the rules surrounding depreciation legislation. Even a general knowledge of depreciation can help investors to make more informed purchase decisions and to plan their investment strategy.
The Australian Taxation Office (ATO) allows the owner of any income producing property to claim depreciation deductions. Depreciation can be claimed in the form of capital works deductions for structural and fixed items such as walls, floors, ceilings, tiles and doors as well as for the removable or mechanical plant and equipment items such as carpets, air conditioners, ovens and blinds contained within the property.
There are some restrictions which apply. The owners of residential properties in which construction commenced prior to the 15th of September 1987 cannot claim capital works deductions for original structural items. They can however claim any more recent renovations completed, including work done by a previous owner of the property. Depreciation for plant and equipment assets is also not limited by the age of the asset. Instead it is based on the condition and quality of each individual asset.
A specialist Quantity Surveyor will perform a site inspection to take measurements and photographs as part of their process of completing a tax depreciation schedule, particularly if there are any loose assets which need to be included in the report. This evidence can be used to substantiate claims in case of an audit by the ATO.
Investors also have an important decision to make when claiming depreciation of plant and equipment assets. Specialist Quantity Surveyors use two methods when depreciating assets. These are known as the prime cost and the diminishing value methods of depreciation. Investors can only choose one method. So it is important for investors to understand how selecting a method will affect their deductions.
Those who wish to build their investment portfolio quickly, to budget for a renovation or who only plan to hold the property for a short period of time might choose the diminishing value method which sees increased deductions claimed within the earlier years of holding the property. Those who prefer to claim deductions at a more constant rate may choose the prime cost method which sees deductions spread out and claimed more evenly over time.
Let’s look at a real example of how claiming depreciation made a difference for one investor.
Patrick purchased an investment property for $495,000 one year ago. He receives a rental income of $455 per week with a total income of $23,660 per annum. Expenses for Patrick’s property including interest, rates, management fees and repairs and maintenance costs totalled to $33,913.
Prior to claiming depreciation, Patrick is experiencing a loss from his property. Patrick contacted a specialist Quantity Surveyor and found out that he would be able to claim $11,590 in depreciation deductions in the first year. The below table shows Patrick’s cash flow with and without a depreciation claim:
Without property depreciation, Patrick would experience a loss of $124 per week during the first year of owning the property. By claiming depreciation, the weekly cost is reduced to $42, saving Patrick $82 per week or $4,264 in the first year of ownership.
Ensuring that each depreciation claim is maximised on any building requires a combination of construction costing skills and thorough knowledge of current tax depreciation legislation. For this reason, it is recommended that investment property owners consult a specialist Quantity Surveyor to prepare a depreciation schedule prior to lodging their tax return. The cost to arrange a depreciation schedule is also 100% tax deductible.
To learn more about property depreciation, click here to visit the BMT Tax Depreciation tax depreciation overview page on their website, or speak with one of their expert staff by phoning 1300 728 726.
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