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Expert quantity surveyor with extensive experience in tax depreciation and property valuations across residential and commercial properties.

What is a tax depreciation schedule and how can it change your tax return?

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Albert Einstein said if you can’t explain something simply, then you don’t understand it well enough. So, it’s time to test my understanding of tax depreciation schedules!

A tax depreciation schedule is simply a report detailing the depreciation entitlements available to you within your investment property. The depreciation entitlements can be broken into two simple categories;

  1. Capital Allowances (Division 43)

Capital allowances are based on the historical construction cost of the property, excluding the value of plant and equipment assets, which we’ll come to in a moment. Capital allowances can be claimed on your original residential property, where it was constructed after the 15th of September 1987, or on any subsequent qualifying renovations or improvements completed by either the previous owner or yourself.

So, to put it another way, say your property was built in 1996. We will estimate the cost to build the property at that time, and you’ll be able to claim 2.5% of the value each financial year. So, if the total build cost was $200,000 and the plant items were $30,000, the remaining $170,000 would attract a 2.5% deduction of $4,250 each financial year for 40 years from the date of construction.

  1. Plant & Equipment Items (Division 40)

Plant & equipment items are generally ‘loose assets’ or control panels for automated systems as defined by the Australian Taxation Office (ATO). The ATO publishes a list of these assets every year around July. In a residential property, the most common plant assets are;

  • Bathroom Accessories
  • Exhaust Fans
  • Hot Water Systems
  • Carpets
  • Vinyl
  • Blinds
  • Curtains
  • Air conditioners
  • Door Closers
  • Security Systems
  • And many more!

These assets are estimated as part of a depreciation schedule, and you’ll generally be able to claim between 100% and 20% of the estimated residual value each year. Each plant and equipment item has a different depreciation rate, but we’re sticking with an overview here.

Therefore, a tax depreciation schedule includes these two components of depreciation and their estimated value. The schedule itself will show 40 years’ worth of depreciation in two different accepted methods. One tends to be more aggressive in the first few years (see diminishing value) and the other maintains a more constant level of depreciation (see prime cost).

Tax depreciation deductions have been boosting investors’ cash flow for years, however changes introduced in the 2017-18 Federal Budget will limit depreciation claims on investment properties purchased after 9 May 2017.

According to the new guidelines, a property investor will no longer be able to claim depreciation on plant and equipment assets installed by a previous owner.  Only components that you have purchased yourself will be claimable.

Properties purchased before 9 May 2017 will be unaffected by the changes.

  1. What deductions can you claim against a property purchased after 9 May 2017?

Capital works

Depreciation of the actual building is still claimable.  Your Quantity Surveyor will still be able to prepare a tax depreciation schedule to ensure you claim all tax deductions you’re entitled to.

Renovation costs and plant & equipment assets you’ve purchased yourself

Similarly, your Quantity Surveyor can list any renovation costs and include them in your depreciation schedule.  New assets you purchase yourself – dishwashers, blinds etc – should also be included in the depreciation schedule and claimed at tax time.

Everything – if it’s a newly built property

Brand new property?  No problem.  The Federal Budget changes only affect second-hand properties so you’ll be able to claim both capital works and plant & equipment deductions as usual.

Now that we know what a depreciation schedule is, how can it change your tax return?

We’re not qualified to provide accountants advice, so you should always speak with them to find out the EXACT impact on your personal situation. Essentially though, the total depreciation comes off your taxable income. Let’s run through a quick scenario.

Let’s say your salary is $88,000 per year, and you have no other deductions. According to the ATO’s simple tax calculator, you’ll be paying $20,507 in tax (2015/2016 year).

We were the first quantity surveyors to publish average deductions in the first full year of claim, this was back in 2015. We’ll be updating our stats soon, but this figure was $9,183 worth of deductions, so let’s assume this figure is available. The $9,183 deduction comes off the taxable income of $88,000 so that brings it down to $78,817. Using the same tax calculator, the tax payable is no $17,162.52.

Breaking that down, a depreciation schedule on this hypothetical, yet average property produced a saving of $3,344.48 within the first full year. An average depreciation schedule is around the $600-$700 mark, so the report is paying for itself five times over within one year.

There are certainly properties that won’t achieve that level of deductions, and some that won’t have anything at all. By the same token, many properties will show over $20,000 worth of deductions within the first year.

The most important thing is to contact a quantity surveyor for an indication of the deductions you might have available to you, as the tax savings can make a huge difference to your investment cashflow and or convert the pain of a trip to the accountant into pure joy!

Mike Mortlock

Mike Mortlock is a Quantity Surveyor and Managing Director of MCG Quantity Surveyors. MCG Specialise in Tax Depreciation Schedules and Construction Cost Estimating for investors. You can visit them at www.mcgqs.com.au/

Our predictions – Property Market Scorecard for 2017 and 2018

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What a year property has had in 2017. We’ve seen some double-digit growth in major capital city markets and a big move from APRA in the investor lending space. We’ve also written extensively about changes to depreciation. There’s also been plenty of debate about foreign investors and housing affordability. So, what did the numbers show us at the end of 2017?

The winner is… Hobart! Hobart saw a 12.86% change in house prices year on year, and 9.13% for units according to CoreLogic. Louis Christopher of SQM Research also predicts Hobart to be the fastest growing city in 2018.

Across the major capitals, Sydney Melbourne and Brisbane saw 3.09, 8.89 and 2.65 per cent growth respectively across all dwelling types. Sydney is notably down 2.1% in the last quarter ending 361 December 2017.

Nationally, dwelling values were 4.2% higher over the 2017 calendar year which is a slower pace of growth relative to 2016 when national dwelling values rose 5.8% and in 2015 when values nationally were 9.2% higher.

According to SQM Research, Hobart and Melbourne are tipped to be the strongest capitals throughout 2018 with Sydney, with Darwin and Perth slowly coming out of their downturns.

We believe there’s deals to be had across Australia in 2018 with some regional areas showing green shoots and extremely affordable price points.

Here’s a look at the SQM predictions for 2018.

Blog 300x160 - MCG Quantity Surveyors

Source: SQM Research

Mike Mortlock

Mike Mortlock is a Quantity Surveyor and Managing Director of MCG Quantity Surveyors. MCG Specialise in Tax Depreciation Schedules and Construction Cost Estimating for investors. You can visit them at www.mcgqs.com.au/

Investors are losing to depreciation changes to plant and equipment

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We recently analysed 1,000 residential depreciation schedules and found that 82% of them would still benefit from having a depreciation schedule completed, given the impact of depreciation changes to plant and equipment. In some ways, it’s good news for investors (and quantity surveyors especially) that the impact wasn’t worse. Certainly, abolishing negative gearing would be a sledgehammer to depreciation and a huge disruption to the property market at large. However, the impact of the depreciation changes is not insignificant.

We’ve been monitoring the impacts closely and have just analysed 100 residential schedules in detail to find exactly what investors will lose under the new system.

To recap, any property exchanged after the 9th of May 2017 will need to be brand new, to claim depreciation deductions on the plant and equipment items. Plant and equipment items are typically loose assets but include things like cooktops, ovens, carpets, blinds, vinyl, air conditioners and hot water systems.

What did we find? Well, our average 1st full year of deductions across this study was a solid $11,628. Now taking into consideration that these were established properties with ‘previously used’ plant items, that first full year figure dropped to $4,758. That’s a loss of $6,870 worth of depreciation deductions. On a 45% marginal rate that’s $3,092 out of your hip pocket within the first year of ownership. Looking over a 5-year cumulative period that’s $16,466 of deductions lost.

To put it another way, 59% of the first-year deductions are blown to smithereens.

Now that percentage drops over time due to the high depreciation rate of plant items. After 10 years of ownership, it’s likely that it’s only the building claims that are left at 2.5% of the construction value for 40 years. However, we do know that however well-intentioned, property investors aren’t holding properties for 10 years plus in general. Investors also know that the period right after purchase is the point where the property is most likely to be heavily negatively geared, and therefore harder to service from a cashflow perspective until the rental income increases to cover the interest repayments. So, to lose 59% of your depreciation deductions in the first year will be a real kick in the guts to most investors.

In most cases (82% as per above), investors will still see some great benefits from a depreciation schedule, but there can be no doubt that the depreciation changes to plant and equipment for established properties will have some serious ramifications for investors and the property industry.

Mike Mortlock

Mike Mortlock is a Quantity Surveyor and Managing Director of MCG Quantity Surveyors. MCG Specialise in Tax Depreciation Schedules and Construction Cost Estimating for investors. You can visit them at www.mcgqs.com.au/

Critical misinformation around property depreciation changes

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The senate has passed the depreciation changes (as of writing it is awaiting royal assent), but unfortunately a number of large quantity surveying firms have been reporting incorrect or incomplete analysis of the changes.

I’ve been modelling the impacts of the recent depreciation changes by analysing the reports in our system as well as looking at the actual impacts of reports we’re doing right now on properties exchanged after the 10th of May 2017.

It’s true that the changes are negative for quantity surveyors and investors alike, but I must again stress that division 43 deductions are unchanged and it’s rare that a property will not attract deductions even with the changes. However, I want to turn my attention to some of the misleading statements.

  1. All second hand properties that have exchanged contracts prior to 7:30pm on the 9th of May 2017 will be grandfathered under the old system.

This is only partly true as there’s a very important caveat. You will only be truly grandfathered if you were eligible to claim deductions during the 2016/2017 financial year. To read straight from the legislation:

(2) The amendments made by this Schedule also apply to the entity, for income years commencing on or after 1 July 2017, for any other asset acquired by the entity, if:

(a) the asset’s start time is during the income year that includes 9 May 2017 or during an earlier income year; and

(b) no amount can be deducted under Division 40, or Subdivision 328-D, of the Income Tax Assessment Act 1997 by the entity for the asset for the income year that includes 9 May 2017.

I am truly sorry for pasting dry legislation in here, but I had to set the record straight! So what this means is that if you exchanged on a property prior to the 10th of May but did not rent the property out until the 1st of July 2017, you WILL NOT BE grandfathered!

Why is this important? Well in analysing 1,000 of our residential depreciation schedules, 22.4 per cent of our investors occupied their property prior to the property becoming an investment. The average duration was 4 years. So if you bought an investment in the last year, last twenty years, you’ll only be grandfathered if it was rented between the period starting 1st of July 2016 and the 30th of June 2017. It’s simply misleading to say that everyone is grandfathered when it’s possible that properties aren’t being rented out prior to the 1st of July 2017.

  1. Plant and equipment depreciation that could not be claimed throughout ownership due to the amended legislation can be claimed as a capital loss to reduce any future capital gains tax liabilities.

This little nugget featured in the draft legislation, and I believed it to be a bit of a ray of hope. I clearly wasn’t alone as there are companies offering ‘deferred depreciation’ reports catering to this way to minimise capital gains tax. I even wrote about this myself suggesting it was a way to recoup those lost deductions so long as there was a capital gain to deduct from. However, according to the tax trainer for the Australian Institute of Quantity Surveyors, this is almost certainly useless to property investors.

The theory was that you bought a 500k investment property with 20k of plant assets. You then sold it for 600k and made a capital gain of 100k which you’d have to pay tax on. However, that 20k could be taken away from the 100k capital gain leaving only 80k of gain. This is so long as all of the previously available depreciation had run out and all assets had a written down value of zero. Certainly possible if you owned the property for ten or more years. However, according to those far brighter than myself, that’s not how it works.

Apparently in this situation you’d need to treat the cost of the land and building as 480k (500k minus the 20k of plant). When you sell for 600k you’re selling the land and building for 600k and the depreciable assets for $0. Therefore you’re making a 120k capital gain on the land and building.

So without getting the depreciation to determine the 20k of plant you’d be treating the land and building as 500k and only make a 100k capital gain. So either way you approach it, you’re getting to the same outcome.

I’d love it if this were not the case as a firmly believe penalising investors is not in anyone’s interest given our reliance on aged pensions but when a former advisor to the Government on tax policy makes the point on behalf of the Australian Institute of Quantity Surveyors, we ought to be listening.

There are a number of other nuances and I expect the tax commissioner will be tested on a few issues over the coming year but for now, it’s important that investors understand these two points and are careful where they’re getting their advice from. The information above is backed by the Australian Institute of Quantity Surveyors.

Mike Mortlock

Mike Mortlock is a Quantity Surveyor and Managing Director of MCG Quantity Surveyors. MCG Specialise in Tax Depreciation Schedules and Construction Cost Estimating for investors. You can visit them at www.mcgqs.com.au/

What you need to know – Investment Property Budget Changes

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Investment property tax deductions hit the headlines when the 2017-18 Federal Budget was handed down on 9 May 2017.

As the second biggest tax deduction after interest, depreciation deductions against investment properties save investors thousands of dollars and can make or break the profitability of a property investment

What deductions can you claim against a property purchased after 9 May 2017?

Capital works

Depreciation of the actual building is still claimable.  Your Quantity Surveyor will still be able to prepare a tax depreciation schedule to ensure you claim all tax deductions you’re entitled to.

Renovation costs and plant & equipment assets you’ve purchased yourself

Similarly, your Quantity Surveyor can list any renovation costs and include them in your depreciation schedule.  New assets you purchase yourself – dishwashers, blinds etc – should also be included in the depreciation schedule and claimed at tax time.

Everything – if it’s a newly built property

Brand new property?  No problem.  The Federal Budget changes only affect second-hand properties so you’ll be able to claim both capital works and plant & equipment deductions as usual.

So how will these changes affect the property market in general?

Experts predict property investors will hold investment properties for longer periods and they may also shift focus towards newly-built developments and commercial investment property opportunities.
Luckily, property investment is a long term game.  A savvy investor can plan ahead by maximising tax deductions that ARE permitted while enjoying capital growth in what is still a strong property market.  Speak to your Quantity Surveyor about how you can maximise depreciation as part of your investment property strategy.

Properties purchased before 9 May 2017 will be unaffected by the changes.

 

For further information relating to the mentioned changes please contact Mitch Ford of MCG Quantity Surveyors on 1300 795 170 or 0419 135 568

Why buying brand new is now the key to maximising your tax deductions

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People often ask me questions like “I should buy a new investment property because it’s better for tax right?” The answer is yes and at the same time, no. Buying a brand-new property because of the available deductions is not a sophisticated strategy. Accountants tell me the same thing, people say they need an investment property because they’re paying too much tax. Makes you think whether they even care about capital growth!

All that aside, here are two all but bankable truths;

  1. Units provide better deductions than houses;
  2. Newer properties provide better deductions than older ones.

Of course, if the unit is tiny and we’re talking about an 800sqm house, that won’t work. Nor will it work for an older heritage property that has had a back to bones renovation with a mega budget. In general terms though, buying a new property will give you better depreciation deductions, here’s why.

On the 9th of May 2017, the depreciation game changed. If you exchange contracts on a property after that date, you’ll only be able to claim deductions on the plant and equipment deductions if the property is new. All other properties purchased before then are grandfathered. Plant and equipment items are typical loose assets but include things like ovens, cooktops, blinds, carpet, air conditioning, hot water systems and the like.

So, we recently took an in-depth look at around 100 of our residential schedules and found that in the first full year of claim 59% of the deductions were attributable to plant and equipment items. That number drops as time goes on due to the high depreciation rates but the impact is a big one.

On top of this, buying new means you’re taking over 100% of the depreciable value of the property, whereas if you buy a property that’s already 10 years old, you will have lost ten years’ worth of depreciation deductions, which would mean at least 25% of the total deductions are gone.

For all these reasons, if you’re considering buying new, you’ll certainly benefit from the perfect storm of elements to maximise your depreciation claims. If it’s an apartment you’re looking at, you’ll also have the bonus of a share of the depreciation on the common areas, and the common area assets like lifts, fire services, lighting, intercoms and much more.

5 things to consider when buying an off the plan investment property

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Buying an investment property ‘off the plan’ has many benefits.  Government incentives, tax depreciation, long settlement terms and the satisfaction of owning a brand-new property makes buying into a new development attractive to many property investors.

 

Here are five things you should consider if you’re looking at an off-the-plan investment property:

 

  1. Do your research

Buying off the plan requires more research than your average investment property purchase.  Location, size, inclusions and market factors will all play a role in your off-the-plan investment property’s success.  Additionally, close examination of contracts and building plans will ensure that you’re getting exactly what you’re signing up for.  Background check the developer and builder, go through expected financials with a fine-tooth comb and be aware of any warranties, insurances, timelines and disclosures.

 

  1. Hire professionals

Off-the-plan contracts can be daunting creatures that contain lots of clauses that don’t appear in contracts for existing properties.  A professional solicitor and conveyancer should be part of your investment team.  A qualified Quantity Surveyor should also be a key player given that depreciation deductions against a newly-built investment property can have a huge impact on profitability and cash flow.

 

  1. Get your money working for you

Purchasing an investment property off-the-plan buys you time.  The developer will require a deposit when you’re signing contracts and then the long settlement period means you can enjoy capital growth while the property is being built.  In the meantime, you can start paying down the deposit or use funds available for alternate investment opportunities – all while you have your off-the-plan investment locked in and in progress.

 

  1. Get in early

Property developers need early sales to get their projects off the ground.  The early bird often catches the best deal.  By getting in early you can choose the property with the best view, the one on the top floor, the one with larger floor space or the property closest to the pool!

 

  1. Be aware of risks and potential delays

As a property investor, you should be pragmatic and keep your emotions in check.  Be aware that the market could shift during construction resulting in lower capital growth.  Delays in construction can and do happen and sometimes developments don’t proceed for many reasons.

 

Thorough research, due diligence and support from your team of professionals will put you on the path to success in the lucrative off-the-plan property market.

Maximise depreciation deductions when buying your own commercial space

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Are you considering purchasing your own commercial space?  If so, capturing and claiming depreciation deductions should be high on your ‘to do’ list.

Commercial investment property owners can save thousands of dollars each year by claiming depreciation deductions for the wear and tear of building structures and fittings.  Depreciation deductions often mean the difference between a negatively geared investment property and an investment property with positive cash flow.

Commercial owner/occupiers can also benefit from the cash injection that results from maximising tax depreciation deductions.  Here’s how?

 

Structure ownership to your advantage

By purchasing a commercial property via a self-managed superannuation fund or trust, you can effectively increase your deductions by claiming the building in one entity, and the tenancy assets in another if you’re operating your business from the same premises.  As a commercial property owner/investor you can claim the depreciation of capital works (the actual building) as well as some plant and equipment items (fittings and fixtures).  As a commercial property occupier/tenant you can also claim tax deductions for the depreciation of fittings and fixtures you’ve installed as part of your business.

 

Engage an expert

All property investors should have a Quantity Surveyor as part of their team.  Quantity Surveyors are experts in tax depreciation deductions.  A Quantity Surveyor will inspect and assess your property and prepare a tax depreciation schedule that will maximize the depreciation deductions you can claim against your taxable income each year. A tax depreciation schedule spells out all deductions claimable for up to 40 years, so it’s a great tool for financial planning and ongoing profitability.

 

Keep accurate records

Meticulous documentation of running costs, upfront costs and day-to-day expenses will be key to ensuring all claimable deductions are captured. You’ll need to keep detailed records of expenditure, assets and financial transactions relating to both the commercial investment property and your business.

 

Use the best depreciation method for your timeline

Your Quantity Surveyor will advise the best depreciation method for your commercial investment property – based on your timeline.  Without going into too much detail, the ‘diminishing value’ method is better for a shorter-term investment, while the ‘prime cost’ method is suited to longer terms of ownership.  Both methods can save you money and your Quantity Surveyor will know which is best for your situation.

 

Get the most out of ‘Year One”

The biggest depreciation deductions are often captured in the first year.  A commercial property investment can depreciate certain items at a higher initial rate than a residential property and there are several tools your Quantity Surveyor can use to maximise the up-front savings you can achieve via depreciation.

If you’re considering purchasing your own commercial space be sure to speak to a qualified Quantity Surveyor as part of your planning.

Occupying your investment – The accidental investment property

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We’ve often wondered how many investors convert their primary place of residence into an investment. We’ve seen a lot of first home owners buy a property for stamp duty concessions or first home owner bonuses and live in their property for 6-12 months before promptly converting it to a rental. However, anecdotally most of the investors that have occupied their investment property fall into what we believe are a group of ‘accidental investors.’

It’s not that they never planned on becoming property investors, it’s fair to say that most of them would have aspired to it, but their investment was purchased primarily as a place to live, rather than a pure investment.
The numbers are significant. Our research team analysed 1,000 of our residential depreciation schedules for the figures. As part of our schedule process, we ask the client whether they have occupied the property or not. The reason is that the depreciation schedule must start as at the acquisition date in most cases, but achieving the best result for the client may mean minimising the deductions for the first few years, as the client is not entitled to depreciation deductions whilst they’re occupying the property.

The stats are in! We found that 22.4% of our clients occupied their investment property as their principal place of residence. The average amount of time spent living in the property was 1,462.8 days or pretty much bang on 4 years. The average length of time came as a bit of a surprise to me, especially when the strategic first home owner/investor would likely be bringing the average down. Perhaps there’s some CGT strategies influencing things here but I don’t believe that to be the case in any significant way. Whatever the reason, be it upgrading the family home whilst in a position with enough equity to keep the old place, it’s interesting to observe that a sizable proportion of investment properties may have been purchased for their liveability, amenities and location, rather than their pure ability to generate cashflow or capital growth. It could also be a reason why the average investor has an investment property quite close to their home and perhaps even partly why investors average only one investment property. Rather than a carefully researched investment decision, these properties are most likely selected based on emotion and the needs and wants of the resident. We all know that the best investments are not always the properties you’d want to live in yourself!

Most importantly for me, these figures come with a big warning.

The recent changes to plant and equipment depreciation (as at 9/5/2017) state that if you occupy your investment property for even one day, you’re effectively killing off all plant and equipment depreciation deductions and will be left only with division 43 deductions (building structure). The average first year deductions for someone that has occupied their investment property is $7,985.64. There’s no magic formula. but half that could be wiped out. Over the investors first 5 qualifying years our figures are pointing to around $14,000 being lost.

So, in a perfect world where everyone operates as tax efficiently as possible, the percentage of investors opting to live in their property will go down. However, as stated above, the investment property often pops up as an opportunity, rather than a shrewd business decision. Time will only tell whether the changes to depreciation will drag the ‘lived in’ investment property stats lower.

Depreciation deductions, an investment property and capital gains tax

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Claiming tax depreciation deductions against an investment property can put thousands of dollars back in your pocket each year.  But will claiming deductions now mean paying more capital gains tax when you sell?

 

What is capital gains tax (CGT)?

CGT is the tax payable on the “capital gain” made while you hold an investment property.  The “capital gain” is the difference between what you bought the investment property for and what you sell it for.

For example, if you bought an investment property for $400,000 and sold it a few years later for $600,000 then CGT is payable on the $200,000 “capital gain” you made.  CGT is calculated at your personal marginal tax rate for the financial year in which you sell the property.

As an owner/occupier you generally won’t pay CGT as long as the property remains your principal place of residence.  Individuals and small business investors who hold an investment property for more than 12 months receive a 50% exemption on CGT.

Tax deductions are claimable for the wear and tear of capital works (the actual building) and plant and equipment (fixtures and fittings) of an investment property.

You can claim tax depreciation deductions by having a Quantity Surveyor complete a tax depreciation schedule – a detailed list of all items that can be depreciated, and how much each item will depreciate each year for the next 40 years.  Your accountant can use this tax depreciation schedule to significantly reduce your tax bill, especially during the early years of your property investment.

 

Will claiming tax depreciation deductions increase the CGT payable?

Probably.  Claiming depreciation deductions for your property’s capital works will reduce the “base” or original value of your investment property.  This effectively widens the gap between what you bought it for and what you can sell it for and increases the “capital gain” on which CGT is based.

CGT may be payable on plant & equipment assets within your investment property, but only if their value at sale time is higher than their value at purchase.

 

Is it worth claiming the depreciation deductions then?

YES!  Either way you will pay tax against your property’s capital gain at your marginal tax rate.  By claiming depreciation deductions each year, you are freeing up cash that can be used to reduce debt or to pursue other investment opportunities – both great ways to increase wealth!

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