Depreciation is one of the best tax benefits a real estate investor is entitled to.
Anyone who buys real estate for profit (eg a rental property) has the right to depreciate the building and the elements it contains against their taxable income.
In fact, seasoned investors typically consider depreciation before buying their next real estate investment.
However, others are none the wiser. This means that every year thousands of dollars go unclaimed.
Custodian CEO and 7 Steps to Wealth author John Fitzgerald urged property investors to learn how to make the most of the tax deductions available to them.
“I’m continually surprised by the number of investment property owners who don’t even claim depreciation on their assets. These deductions can be quite large, I’m talking thousands of dollars, especially when you’re buying a brand new investment property.
If you haven’t claimed capital cost allowances on your rental property, the best time to learn is now. So here’s our basic guide to how rental property depreciation works.
What is rental property depreciation?
To begin with, let’s understand what depreciation is. Simply put, depreciation is a financial term used to describe the decrease in value of an asset over time due to wear and tear.
This also applies to investment properties. As a property ages, the structure of the building and the assets it contains wear out. In other words, they depreciate.
So what is rental property depreciation? Real estate depreciation refers to a tax break that allows investors to offset the decline in value of their investment property against their taxable income.
In Australia, investors can claim tax deductions both on the decline in value of the building structure and items considered permanently attached to the property and on the decline in value of plant and equipment assets found in the real estate.
Not only does this help investors pay less tax, but it is also a “non-monetary deduction”. This means you don’t have to pay for it on an ongoing basis, as the deductions are built into the purchase price of your property.
What rental property depreciation expenses can you claim?
Australian law allows investors to claim tax deductions on the depreciation of rental property assets under two categories: capital works and capital deductions (e.g. plant and equipment assets).
Capital works deductions refer to claims an investor can make for wear and tear that occurs on the structure of the rental property.
Fixed assets are all fixed elements such as the roof, walls, doors and kitchen cabinets. examples of work fixed assets which are eligible tax-deductible depreciation expenses include:
- renovations or extensions (e.g. adding an extra room or a garage to your rental property),
- modifications (for example, removing or adding a wall), and
- structural improvements (for example, adding a driveway or inserting a retaining wall).
Owners of residential properties whose construction began after September 15, 1987 can claim capital works deductions, which can be claimed at a rate of 2.5% per year for forty years.
If your rental property was built before this date, you should still find out about the capital cost allowance available, as these buildings have often undergone some form of renovation, which can trigger capital works deductions.
Meanwhile, if you purchased a rental property that was significantly (not cosmetically) renovated by the previous owner prior to the sale, you are also entitled to claim the associated capital works deductions within the 40 years.
In this scenario, it is advisable to hire the services of a quantity surveyor who will be able to assess and identify renovations that are not at surface level, including new plumbing or electrical wiring brought up to date. day.
Additionally, if you eventually delete capital works assets during the 40-year period, you can claim any depreciation that was not deducted in the year the asset is deleted in a process called discarded”.
- Industrial and material assets
Plant and equipment assets refer to removable fixtures and fittings that are in a rental property. Depreciation allowances for these assets are calculated based on their individual effective life as defined by the ATO.
For rental property investors, this may include light fixtures, stoves, rugs, an air conditioner, or a trash can.
If you’re not sure which items you need to include, the ATO lists all the items you can claim – and for how long. The ATO provides a comprehensive table of estimated effective life of a wide range of potential rental real estate assets.
If you want to make sure you don’t miss anything, you can hire the services of a quantity surveyor to appraise your property’s fixed assets to provide you with a depreciation schedule.
You can also calculate the determinable useful life of your assets yourself and depreciate them accordingly. But remember that you must be able to justify your calculations to the ATO.
There are two methods you can use to calculate the amount of depreciation you can claim on rental property, plant and equipment:
Depreciation of the asset would be spread evenly over its effective life. For example, a $1,500 asset with a finite useful life of five years would be depreciated at $300 per year.
- The decreasing cost method
Annual depreciation is calculated on the depreciated (i.e. decreased) value of the asset each year of its useful life. This means that the capital cost allowance tax is highest in the early years of the asset’s life, rather than being evenly distributed as is the case with the cost basis method.
Full depreciation of rental property, plant and equipment costing $300 or less can be depreciated in their first year of use. However, tangible capital assets costing more than $300 must be depreciated over their estimated useful life.
What are the legislative changes of 2017 in terms of depreciation? Why is it important?
Note that from July 1, 2017 (as announced in the May 2017 budget), real estate investors can only claim tax depreciation of installations and equipment if you have actually purchased them yourself or if they have been included in the new property.
You also cannot claim depreciation on a property you buy if you live in your rental property while you renovate it.
On the other hand, you can still claim depreciation for any new plant and equipment you buy and install in the property once it produces income.
For example, if you purchase a new hot water system while your property is rented, you are entitled to claim depreciation on that asset.
It is recommended that investors only purchase new fixtures and fittings if they do not live in the property and it is either rented or available for rental.
What records do you need to keep to claim depreciation?
Keeping track of necessary documents will help you claim depreciation more easily at tax time.
For fixed assets, the following expenditure records over the 40-year eligibility period must be kept:
- details of the type of construction work carried out,
- the start date of the work,
- the date on which the work was completed, and
- the overall cost.
All other records of rental property depreciation expenses, such as tangible capital asset receipts, must be kept for the estimated life of the asset and then for another five years after you file your tax returns.
How do I claim the depreciation of my rental property?
The most convenient way to claim depreciation for your rental property is to get a tax depreciation schedule prepared for the property.
A rental property depreciation schedule is a document that provides you and your accountant with the proper information regarding depreciation claims for your property. Simply put, the amortization schedule contains relevant data regarding compensation for the wear and tear of the building.
To obtain a tax depreciation schedule, all real estate investors need to do is have a qualified quantity surveyor inspect their home. A qualified quantity surveyor will ensure that all depreciable items are noted and photographed. This will ensure that you will not miss any deductions. The documentation can then be used as evidence in the event of an audit.
How much will an amortization plan cost?
The cost of preparing a tax amortization schedule depends on several factors, including the type of investment property you purchased, its location, and its size.
Most of the time, surveyors offer a money back guarantee to save you double your first year fees, or they give you the report for free.
To further sweeten the deal, quantity surveyor fees are 100 percent tax deductible. So you have absolutely nothing to lose and plenty of tax deductions to gain.
It is important to claim everything eligible tax deductions to maximize the return on your investment property. Be sure to visit Smart Property Investment Tax and legal page for the latest updates, ideas and advice on tax and legal strategies for investors.
Real estate is a type of real property that refers to any land and its permanent improvement or accompanying structures, whether natural or man-made.