The ultimate guide for Tax Depreciation

What is Tax Depreciation?

Depreciation is the process of claiming a deduction for natural wear and tear on your property. The Australian Taxation Office allows owners to deduct this expense, unlike other types where you need outlay money in order make that claim.

What is Tax Depreciation?

Depreciation is the process of claiming a deduction for natural wear and tear on your property. The Australian Taxation Office allows owners to deduct this expense, unlike other types where you need outlay money in order make that claim.

 

Under the current Australian income tax system, you are allowed to claim certain deductions for expenditure incurred in gaining or producing assessable income. Depreciation is a non cash deduction which can be claimed by most property investors. To claim for Tax Depreciation deductions you will need to file under two sections of the income tax act: ITAA 1997, Division 43 (Capital Works) often referred to as “building or structure” and Division 40 (Capital Allowances) often referred to as plant and equipment.

There are two methods that you can use to calculate depreciation, the first being Prime Cost method which assumes that the value of a depreciating asset decreases uniformly over its effective life or Diminishing Value method which assumes that the value of a depreciating asset decreases more in the early years of its effective life.

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Capital Works (Division 43)

Buildings, structural improvements, alterations, and improvements are all eligible for Capital works deductions under Division 43 of the Income Tax Act 1997.

Capital Works cost base is typically calculated using the actual construction costs including prelims and fees. Where this isn’t available you can get an estimate from a quantity surveyor or other independent qualified person. Depreciation on capital works will depend on when they were started as well as what type of property – with rates ranging anywhere between 2.5% and 4%.

The following example demonstrates typical assets classified as Capital Works in nature on both a residential property and commercial property:

Residential and Commercial Property Capital Work | Koste

It is possible that a typical Division 43 asset shown in the table, may be part eligible under Division 40 (Plant and equipment). For instance, a ducted air conditioning system will qualify plant and equipment under in Division 40 for the motor component, while its ducting will fall under Division 43 of capital works.

As you can see, one solution does not fit all. It is recommended to speak with a quantity surveyor especially on commercial properties. This will ensure the correct tax treatment and maximum deductions.

Which Assets Qualify for Capital Works Deductions

 

It is important to have a Quantity Surveyor prepare your Tax Depreciation schedule, as there are many complexities around the tax legislation. Some sections of your building asset may be eligible for part capital works deductions as well as plant and equipment.

Capital works deductions make up to 90% of total depreciation which can be claimed on building and structural improvements. These assets which are usually fixed in nature are written off over 40 (2.5% annually) or 25 years (4% annually) depending on the asset type and year works were completed.

Today - 27 Feb 92 26 Feb 92 - 16 Sept 87 15 sept 87 - 18 Jul 85 17 Jul 85 - 22 Aug 84 21 Aug 84 - 20 Jul 82 21 Jul 82 - 21 Aug 79
Traveller Accommodation 4% 2.5% 4% 4% 2.5% 2.5%
Non-Residential 2.5% 2.5% 4% 4% 2.5% N/A
Manufacturing 4% 2.5% 4% 4% 2.5% N/A
Residential 2.5% 2.5% 4% N/AN/AN/A
Structural Improvement 2.5% N/AN/AN/AN/AN/A

As a rule of thumb, all residential properties whose construction commenced after the 15th September 1987 qualify for capital works deduction at an annual rate of 2.5% for a maximum of forty years. Commercial properties, however, have varying rates of 2.5% and 4%, depending on the type of capital works, commencement year of the construction, and property usage. The following table will provide you with an indication of the important dates.

Tax Depreciation Schedules

@Not familiar with Tax Depreciation Schedules? We’ll quickly explain the benefits for you now:

“A depreciation schedule is a report carefully prepared by a Quantity Surveyor that will detail the value of your building, structure, and fixtures over a period of time.”

The schedule is used at tax time when you complete your tax return to reduce your taxable income and enhance your cash flow. Ideally, you will order your Tax Depreciation Schedule before the 30th of June so you can claim tax deductions for the past financial year and enjoy your maximized cash flow immediately!

Capital Allowances (Division 40)

 

Generally, items in your property with shorter lifespans, motorized and easily removable, will fall under the category of Capital Allowances. Under Div 40 of the Income Tax Act 1997 the definition of capital allowances often referred to as plant and equipment is defined as the following:

“Assets with a limited effective life that are reasonably expected to decline in value over time”

Residential Assets Commercial Assets
Dishwasher Cooling Tower
Rangehood Bili Tap
Downlights Spit fire lights
Oven Removable partitions
Split Air Conditioner Reception Desk
Carpets Workstations
Blinds Signage

Typical assets categorised as Capital Allowances (Division 40)

The applicable tax depreciation rates for plant and equipment will differ both for commercial and residential property. The ATO is charged with determining the effect life of thousands of assets under all asset classes through Tax Rulings which is updated periodically. 

As you’d imagine, plant and equipment allowances grant investors accelerated depreciation due to the effective life being much shorter than typical assets which fall under the category of capital works. It is beneficial for an investor to claim plant and equipment allowances over capital works as deductions can be depreciated over a few years, maximizing income tax deductions. The skill of the Quantity Surveyor will be needed to identify and value as many assets as possible under plant and equipment.

Generally, for a quantity surveyor to understand the treatment of plant and equipment, they’ll request information about your type of building (residential, commercial, warehouse, guesthouse, etc.) dates when built, any improvements made and costs, to ensure maximum deductions can be claimed.

Notable Changes in Residential Tax Depreciation Laws

Wakerley

If you bought a second-hand residential property after the 9th May 2017, you may be affected by the changes to the tax depreciation laws introduced. In the 2017/18 budget, the Government announced measures to assist with the problems of housing affordability. These measures affected the tax legislation in relation to investment properties which limited plant and equipment.

These changes were implemented to stop entities claiming inflated deductions relating to their rental properties by ‘refreshing’ the values of previously used depreciating assets in residential rental properties.

Furthermore, the legislation changes on the second-hand property now defer the depreciation benefit for the decline in value of Division 40 plant until the sale of the property.

As a result, the amounts that would previously have been claimed under Division 40 plant are now utilised at disposal and form the basis of a CGT event. Any capital loss will be offset against the capital gain incurred on the sale of land and buildings.

Residential Property Example

 

Since the introduction of the legislation, many properties are still unaware of the impact of the changes. The following example provides an example of the tax implications on a residential property purchased for $425,000 and disposal of $750,000 over a 5-year period with tax calculated at an average 37%.

As the example demonstrates, there is no difference in the total tax payable over the 5-year period. The only changes are on claiming the tax benefit and the impact on cashflow. Although your second-hand property may not be eligible to claim Division 40 deductions immediately, any deferred depreciation benefit should still be calculated and reported as a “Capital Loss” when you sell the property. To find out more about these legislation changes, please click the following link:

Explaining May 9th Tax Depreciation Regulation Changes That You Need To Know 

If this short guide doesn’t adequately cover your case, be sure to engage an expert at Koste Chartered Quantity Surveyors to make the most of the tax deductions available to you. Also, consider taking our eligibility test to find out how much you can deductions claim. On average, our clients claim up to $9,000 in tax depreciation deductions each year.

See you on the other side!

Book in a call to receive a free tax depreciation estimate.

If you have recently purchased an investment property or even if you
have been a long-time investor, give Koste a call to discuss how we can
help you reduce your taxable income and improve your cash flow.