Tax…is there anything more tedious… Wait, what about tax that provides income returns from your property investment? That does get a little more exciting.
Investment properties and their contents are subject to wear and tear, especially when you have tenants living inside and using the premises every day. It’s just natural and expected that some damage and wear will creep in over time.
The ATO acknowledges the decrease in asset value and has set up a timeline for individual asset life expectancy. This means that even though the expenses of asset depreciation might not be covered in rental earnings, you can claim investment property depreciation against your taxable income.
For example, if you buy a new carpet for $6,000 ATO lists this value expectancy as ten years. This means you can claim a $600 tax deduction every year for ten years under straight-line depreciation (Prime Costs). We’ll get into the formula for calculations a little later in this blog.
For those who have been in the property for a while, this won’t come as a surprise, in fact, those with experienced property portfolios will calculate depreciation and factor this into their future yield before a property purchase price is set and the contract is signed. This is because tax allowances not only make property investing affordable for the average Australian but also create a big incentive to take the next step from owner/occupier to investor.
While many already know the ins and outs of property depreciation, this blog does have a purpose as there have been a number of new landlords entering the market recently who might be tackling rental income and the property tax for the first time. There’s a lot to take in and factor but the benefits are well worth the time.
You purchased your property and the included fixtures within it for long-term value and ongoing income. Unfortunately, while the land may increase in value over time, many other elements of your purchase will not.
The older appliances and fittings get, the more maintenance, repairs, and upgrades are needed to keep your income high. This need for ongoing work and depreciation of certain parts of your investment is considered a loss - especially if the property is purchased brand new, or has been heavily renovated with all new appliances, fittings, and flooring.
Because your property is an asset, you are able to claim tax deductions on your income that helps to reclaim some of the wear and tear costs that take place with time.
For investment properties asset depression can be applied to a large number of removal features including:
Claiming these deductions is carried out through the property depreciation tax break that allows investors to offset their investment property's decline in value from their taxable income.
In order for depreciation to be accounted for a quantity, the surveyor will prepare a report that includes a depreciation schedule. This will go to your accountant (if you have one) for them to use as part of your income report. The quantity surveyor will usually inspect the property condition and write a report at the time a rental property is purchased.
Make sure you hire an approved independent third-party quantity surveyor to do your asset value assessment and depreciation schedule. An accountant, real estate agent, or property valuer is not qualified to do this as the ATO takes in different considerations outside property value. Depending on your assets and plans for future deprecation claims you might need to hire more than one professional to get all the data you need to make your various claims.
Just like with all professionals who are required to help you secure your property purchase, from bank lenders to conveyances, always check their credentials and make sure they have the local experience to help you make a solid choice. For quantity surveyors, make sure they are members of the AIQS.
There are two categories of investment property depreciation claims that can be made under:
If your property is furnished or partially furnished as part of your rent you can look at the depreciation value of these fixtures such as appliances (i.e fridge, TV, washing machine) and furniture you own but tenants use as part of their rent.
Over the life of the item, you get your fixture investment cost back by the time it needs to be replaced. If you use the property or the item for personal use for any length of time, you’ll need to adjust your calculations to only include the times this item was used as part of your income.
This means that when it comes time to update your property and bring it up to speed to increase sale value or income through rent, you have financial resources available for new paint, carpets, air conditioning maintenance, roof replacement, or bathroom renovations.
This is good news for investors. In most cases, property investment income comes in on top of paid annual income, so you are pushing into upper tax brackets for higher income earners, so the relief of tax cuts that give you back some of your hard-earned income is welcome.
The cost of your report and schedule is something you can claim on your tax and once you complete this requirement at the start of your property journey, you won’t have to do it again. Under the non-cash deduction, you are able to have your depreciation automatically built into the purchase price of your property, since the calculations can be made from the purchase point and set annually. This is different from interest levity deductions which you will need to keep paying for in order to make your claim.
Just note that depreciation only applies to properties that are considered as income, which means you do need to have your property available for rent annually - which usually excludes holiday homes.
Once the property condition report has been finalized for depreciation you will be able to claim an ascension tax depreciation in your next end-of-financial year income reporting.
There are two ways to calculate depreciation.
In most cases property investors choose diminishing value as the returns tend to be better, however, it’s highly recommended you discuss the type of assets you are claiming and the best method for your claim with a certified accountant.
Understanding how each of the two depreciation methods works is key to knowing which to apply to the asset you have. It’s also important to stay updated on any changes that might occur with lodgments or reporting so you can meet ATO criteria easily and seamlessly.
The first option for calculating depreciation is Prime Cost. Prime Cost is based on a uniform depreciation over the life of the asset - i.e. there is a consistent and regular drop in value. The calculation for this is:
For example, if you needed to purchase a hot water heater for your investment property on July 1st. Come tax time you will calculate the depreciation as the price of the asset ($10,000), the time you had it (which is the full 365 days), and how long the asset is expected to last (15 years).
$10,000 × (365 ÷ 365) × (100% ÷ 15)
$10,000 × 1 × 6.66% = 666.67
This would enable you to claim Prime Cost Depreciation of $666.67 every year for 15 years.
The only difference would be if you sold or disposed of the asset within the 15-year timeframe.
Further details for the calculation of asset lifetimes are available on the ATO website.
The diminishing asset value calculates how an asset will lose the largest portion of its value at the beginning. You claim more in the early years after the purchase and the amount you have claimed is deducted from the following year’s asset value estimate (base value).
The calculations look like this:
Year one: Original base value × (days held ÷ 365) × (200% ÷ asset’s effective life).
Subsequent claims: (Adjusted base value - previous year’s claim) × (days held ÷ 365) × (200% ÷ asset’s effective life).
Let’s say you purchase a hot water heater for $10,000 on July 1st that will last for 10 years
Your first-year calculation will be: 10,000 x (365÷365) x (200%÷10)
Year 1 tax depreciation claim: $2,000
Second year calculations: (10,000- 2,000) x (365÷365) x (200%÷10)
Year 2 tax depreciation claim: $1,600
Third year calculations: (8,000 - 1,600) x (365÷365) x (200%÷10)
Year 3 tax depreciation claim: $1,280
Fourth year calculations: (6,400 - 1,280) x (365÷365) x (200%÷10)
Year 4 tax depreciation claim: $1,024
This would continue and diminish in claims until the life expectancy is complete - in this case ten years.
While overall you get roughly the same amount of returns in the long run when compared to the prime cost method, having more money upfront is a bigger incentive to replace assets sooner, rather than let them deteriorate and age too badly. It just helps keep your property value higher and maintained more regularly.
Owners who purchase a property that is built after September 15, 1987, can claim wear and tear on structural items (i.e. roof, walls, stumping) for up to 40 years. This includes renovations - although you’ll need invoices that show renovation costs or pay to have an evaluation carried out so the ATO has the details of the starting value.
The typical rate of calculating returns is 2.5%. Talk to your accountant about how this works. It’s best to make sure your accountant has experience with rental property investments and deprecation claims so they can represent you correctly.
If you didn’t know about property depreciation and you have already purchased your property you can still go back and amend your tax. In some cases, you can make deprecation claims as far back as two years ago. Talk to your account or the ATO directly on how to get started on your catch-up.
As well as income and the security of owning property that will earn capital gains over time, it’s reassuring to know you can maintain and update your property features affordably. As always, make sure you hire the right professionals to help with your property purchase and ongoing income. The right team behind you will ensure you get the right advice, the best communication, and genuine help to meet your property goals.
Saving for a home loan deposit and going through the motions of applying for mortgage loans is a handful for any Australian, but it can get that much trickier if you’re self-employed. As well as juggling your business you also need to prove your worth.While you might need to jump through a few extra hoops, it’s not impossible to own your home or upgrade if your existing home is getting a little small.
In an effort to make owning a home more manageable for average Australians, particularly those renting and looking to purchase their first home, the Australian government is opening up more and more incentives to make it possible.One of these boosters is through Superannuation.
We know what you’re thinking – not another email sign-up!
But hear us out.
Our monthly update is full of valuable news and advice on all things property.
Sign up and your future will thank you for it.