Depreciation is something investors refer to a great deal. Some investors will place it well to the forefront of any strategies they craft. But what exactly is it and how can you use it to maximise your property returns?
What is it?
Firstly, let’s break down the definition. Depreciation allows anyone who has bought a property for income generating purposes (ie. investment) to claim back the wear and tear and any resulting devaluing of the property. The concept is that every property loses value almost immediately that it’s purchased. Why? Because, like any commodity, it ages and needs repairs and so is considered to be less attractive to the market as time moves forward.
What can you claim?
There are two kinds of depreciation: plant and equipment, which means internal items such as ovens, fridges, curtains, dishwashers, free standing furniture, oven cooktops, etc – anything you’ve bought as an investor for the house that isn’t part of the building. Then there’s building allowance also known as capital works. This means the actual bricks and mortar of the building or the chimney or doors, toilets, windows, guttering - anything that’s been constructed as part of the property. Both of these can be used separately to claim tax deductions from your rental income.
When in doubt about which goes with which - a good rule of thumb is: can you remove it from the property? If it’s physically fixed to the property (toilet, windows) then it comes under capital works. If you can remove it “easily” (i.e. not rupturing an arm to do so!) such as a carpet or a range-hood, then it comes under plant and equipment. This is also referred to as fixtures and fittings.
How do you claim?
You’ll need to hire a licensed Quantity Surveyor. They will take photos of the property and make detailed notes about every aspect of the house and surrounds. This then informs what’s called a Property Depreciation Schedule. This lays out exactly the deductions that can be claimed on the property in question. Then this goes to your accountant or financial advisor and is used in the tax returns.
How much do Quantity Surveyors cost?
The cost of surveying your property and creating a depreciation schedule will be based on a myriad of factors such as the property’s size; its location; its property type; the age of the house and many other aspects. On the plus side, Quantity Surveyor fees are 100% tax deductible. Quantity surveying is a highly technical job with a deep knowledge of construction costs and the surveyors aim to improve their clients’ financial position through astute advice about depreciation.
When is the best time to survey the property?
Ideally just after you’ve bought it (i.e. after settlement) and before the tenants move in. This means there’s minimal disruption and it will be quicker and easier for the Quantity Surveyor to do their job. The sooner you have a Depreciation Schedule the sooner you can begin claiming.
You’ll need to hire a licensed Quantity Surveyor to prepare a Property Depreciation Schedule - your accountant will use this to claim your depreciation.
How old does the property have to be to claim the depreciation?
It’s commonly thought that only new builds can claim the depreciation. However this is not true. Older buildings can also claim the depreciation. But the ATO has determined a limit, which is 40 years from construction. It’s set this time span as being a natural life of a building, so if your property was built before 1970 you may not be able to claim the depreciation.
Can you explain why there is greater depreciation on new builds?
New properties will usually achieve a greater rate and overall amount of depreciation because investors can reach the maximum Capital Works Allowance. They’re starting out with the property being at its absolute peak and thereafter everything will undergo wear and tear.
How much can you claim?
For the Capital Works Allowance, it’s a flat rate of around 2.5% per annum for most properties. The buildings have to have been built after 17 July 1985. For instance, if the building costs for the structure of a property came to $240,000 then you would claim back $6,000 per annum in depreciation. For other depreciation (i.e. plants and equipment) it’s not a flat rate and is based on the items themselves.
Is there a timeframe on depreciation for fixtures and fittings?
Each item has its own natural life set by the ATO and so the depreciation claim is calculated accordingly. This is because some items will last longer than others and there are many factors such as: the manufacturer, the item’s use in the household and the age of the item. So there’s no hard and fast rule. For example, microwave ovens can have an effective life of ten years but ceiling fans only five years.
For full details visit the ATO website. However, a few quick things to note: the rules on depreciation will be different if the item is part of an identical set (i.e. six identical chairs that are all the same colour, age and make). Also that the depreciation of an item is determined from the time taken from its date of purchase, not when you start using it in the investment property.
Can you claim renovations made by a previous owner?
Yes you can, depending on a few things. You’ll still need a Quantity Surveyor to look at it and estimate the depreciation on the improvements. Renovations are not always immediately obvious. For example if internal electricals have been upgraded or plumbing work done. Ask for reports of work done where possible. There’s also an important caveat that to claim tax deductions on capital improvements to capital works, the construction/renovation must have taken place after the 18th of July 1985 for residential and after the 20th of July 1982 for commercial buildings.
Can you claim renovations that weren’t intended to add value or produce income?
Yes, as long as the renovations were made after 30th June 1997.
What if I want to renovate the property?
You can still claim depreciation. The Quantity Surveyor will document the property and produce what’s known as a scrapping schedule. This will put a dollar value on all the items to be thrown away or removed. This then goes into the depreciation schedule.
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What’s the best way of using depreciation as a strategy?
There’s multiple ways you can use depreciation as a property investor. If you are negatively gearing then depreciation will be at the cornerstone of your approach. In the meantime, while you negatively gear, your property is enjoying capital growth. But equally, depreciation also helps with positive gearing, as the tax return you get from the ATO is valuable capital that can be used to go back into the property. What makes depreciation so attractive is that it’s what known as a non-cash loss. In other words, you’re never actually physically out of pocket.
Can you recommend a good supplier?
DPN recommends the quantity surveying company Washington Brown.
Is there a song that sums up depreciation the best?
Yes. Either Money for Nothing by Dire Straits or Been Down So Long (It Looks Like Up To Me) by The Doors.
If depreciation was a vegetable what would it be?
Celery. A long growing season, hard to get the temperature just right, but very crunchy and tasty when it’s ready to go.
This information is provided by DPN Pty Ltd ABN: 94 630 700 186 Australian Credit Licence 514759. DPN Finance Pty Ltd is an authorised credit representative 504129 and related entity of DPN. Credit for Dream Big 100% Offset and Work Smart 100% Offset is provided by Adelaide Bank a division of Bendigo and Adelaide Bank Ltd, ABN 11 068 049 178 and Australian Credit Licence 237879. Casa Capace Operations Pty Ltd, NDIS provider number 4050038018 trading as Casa Capace.