Category: Information

The recent regulatory changes and the state of the Property Market

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The January CoreLogic figures have shown that capital city dwelling values have posted their first quarterly fall since April 2016. The peak of the market was called as far back as 2016, but now we’re seeing the evidence some two years later. On a positive note, the combined regionals edged slightly higher over the Dec-17 quarter and there are clearly some strong investor opportunities outside the capital cities.

The quarterly capital city falls were led by Darwin at -2.9 percent and Sydney at -2.1 percent.

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It’s interesting to see Melbourne sitting neutral (0.9%) over the December quarter compared with Sydney, especially given Sydney lagged Melbourne’s price growth over the 2017 calendar year by 5.8 percent. However, even with Sydney dwelling values down 2.1% over the final quarter of 2017, they’re still 3.1% higher over the past year.

In good news for investors, the annual rate of rental growth is higher than a year ago across most capital cities, with a bit of weakness shown at the end of 2017. That being said, gross rental yields are starting to trend higher, with rental growth outpacing value growth in many cities.

The regulatory changes have had a huge impact on investors and interest-only loans have fallen off a cliff. It will be interesting to see how long APRA and the banks hold this stance, my guess is the banking royal commission will keep their appetite for investor lending to a minimum in the short term.

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How common property assets can supercharge your upfront deductions

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Most investors would be aware that if you own a unit within a complex, you’ll have an entitlement to claim over the common property assets based on your share of ownership. This percentage share is commonly referred to as a unit entitlement and can be found on your strata plan or plan of subdivision. You’ll see an entitlement per lot and then an aggregate for the sum of all lots.
So, if your unit entitlement is 60 and the total of all lots is 800, then you’ll have a 7.5% claim on the common assets. Typically, within larger developments, your percentage claim is very small, but it can still contribute significantly to the claim based on the high values of common assets.

There are two main common property depreciation categories, the building structure and the plant assets.

Common area deductions can give your depreciation schedule a real kick in the pants, here’s why.

If we look at the building structure in isolation, the sheer construction value of these areas can lead to significant claims. Your specific unit may have a construction cost of say $200,000 or thereabouts, but the complex consisting of foyers, levels, basements, gyms, pools and the like could be in the tens of millions of dollars. Take for example a unit at 618 Lonsdale Street Melbourne. The construction value of one of the units we estimated to be around $1550,000 excluding plant, whereas the common areas came in at around 35 million. Based on the typical unit entitlement within this development, around $73,000 worth of common property building areas are directly attributable to each investor.

However, the real kick for the upfront deductions can be found in the plant and equipment assets. Thanks to ScoMo, our esteemed federal treasurer, these plant deductions are now only available to brand new units. Out of interest, at MCG 38.3% of our residential reports are on brand new houses or units.

Looking again at 618 Lonsdale Street, we found 35 separate plant and equipment categories. These include things like lifts, carpets, fire detection alarms, ventilation fans and the like. We found almost a million dollars’ worth of common property air conditioning plant but based on an individual unit entitlement, this gave a total of $1,903 to the investor as a deduction depreciating over 15 odd years. Air conditioning is one of those typically high-value assets within a large residential complex, and it’s not typically something that provides a high upfront deduction. The good news is that most things do. Of the 35 separate categories, 25 of them provided 100% of their depreciable value to the investor in year one.

Why? Well, assets that have an opening value of less than $301 that are not part of a set, can be written off at 100% right away. So even though there might have been over $35,000 worth of door closers for example, the individual investors share came to $150 in total. Door closers are one example of an instantly deductible asset but typically we also see things like gate motors, barbeque assets, fire alarm bells, fire extinguishers, gym assets like treadmills, pumps, proximity readers, swimming pool filters and more. Looking at the Lonsdale street case study, we uncovered $2,223 worth of instant deductions on these common property assets.

Common property is certainly the reason why units provide better deductions than houses in general, but it’s also interesting to analyse the way those deductions fall into the schedule. For a long list of items, those deductions will hit within the first year of ownership, which can provide a significant cash flow advantage to the investor.

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.

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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/

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.

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.

Draft Legislation for Depreciation Changes Issued by Treasury

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On Friday the 14th of July, the treasury finally issued their draft legislation relating to the changes to depreciation for plant and equipment items. Personally, the most positive thing about the draft is that it’s silenced the fear-mongering commentators saying that depreciation on plant and equipment would be stripped from new properties. This was never implied as part of the budget speech and it has been confirmed that new property will remain unaffected, such as with commercial properties.

The explanatory material released with the draft legislation highlights the governments fear about “refreshed” second-hand plant and equipment values. In an article by the Australian Financial Review (http://www.afr.com/real-estate/residential/landlords-face-loss-of-950-a-year-in-deductions-on-typical-renovation-20170518-gw7jod) the ATO anonymously referenced a depreciation schedule they saw with second-hand values roughly 10x what they believed to be reasonable. Unfortunately, rather than dealing with the offending firm(s), treasury and the ATO have teamed up to penalise all investors by scrapping all depreciation on previously used plant and equipment assets.

One particular firm has been heard saying that they get back more deductions than anyone else which is frustratingly misleading. One wonders whether they’re believing their own spin or are the offending party referred to above. Sure, there are some firms that aren’t depreciation specialists and will miss ways to maximise a claim, but once to get to the specialist firms, the ATO rules apply to everyone, and the estimated values should be similar.

The term “previously used” popped up several times in the legislation, and it does confirm that previously used assets are any plant and equipment assets that existed within a property prior to an investor purchase, whether it was owner occupied or tenanted. So, unless you either buy the property new, or pay for the assets yourself such as adding some carpet, you won’t be able to claim plant and equipment deductions. If you’re living in your property while you renovate it and then sell the property to an investor, the investor will have no plant claims as the assets are deemed previously used. This is not the case if you renovate your property while tenanted, you’ll be able to claim those plant values.

The treasury has suggested that these changes will fix the issue of “refreshed” 2nd hand values. I cannot for the life of me see how this will fix the issue entirely, as the depreciation that you were able to claim under the old rules, can now be treated as a capital loss at the time of sale, reducing your capital gains tax. In sexy ATO speak: To the extent that an entity’s deductions for an asset are reduced because of these amendments, when the entity ceases to use the asset the amount of any balancing adjustment is reduced and the proportion of the decline in value of the asset is recognised as a capital loss.” 

So, you buy a 5-year-old house for $500,000 with $20,000 worth of plant and equipment assets, sell it in a few years for $600,000 and the residual (left over) plant value is $5,000, then the $15,000 ($20,000 starting value minus the $5,000 residual value at sale) that you would normally have claimed as depreciation against your assessable income will now be a $15,000 capital loss.

On a taxable income of 45%, that $15,000 of plant deductions would have equated to around $6,750 back in your pocket. Now that it’s not a deduction and is a capital loss, you’d be looking at your $100,000 capital gain dropping to $85,000. With the 50% CGT exemption, you’re now looking at a $42,500 gain. Taxed at your 45% marginal rate, you’re incurring a capital gains bill of $19,125. Without the $15,000 capital loss, it would be $22,500. So you’re saving a difference of $3,375 in capital gains tax.

Sure, that $3,375 is a lot less than $6,750, but to say that there’s now no incentive to inflate the residual values of plant and equipment assets is misleading. There still exists the incentive, it’s just about half as enticing as it used to be. So, for me, it’s far from mission accomplished. Google hard enough and you’ll find some better ideas I have to fix the problem, but to keep this brief I want to move to some analysis.

We’ve not completed a tremendous number of reports for clients that exchanged after the 9th of May just due to it only being July at the time of writing. However, we’ve analysed the first 8 reports we’ve completed and here’s the real-world impact of the changes.

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So as you can see, it’s costing an average of over $5,000 worth of deductions within the first full year of claim and just under $20,000 for the cumulative first 5 years. Remember this is only for recent purchases of established residential properties, but it’s quite significant.

As written previously (https://www.mcgqs.com.au/blog/detailed-analysis-of-the-budget-changes-to-tax-depreciation-on-plant-and-equipment-budget2017/) we’ve calculated that in 83.9% of cases within our analysis of 1,000 schedules, an investor would still benefit from a depreciation schedule as building component deductions, new properties and renovated properties will continue to provide valuable deductions. With the capital loss announcement, it’s important to have a report to see the decline in value of your plant and equipment anyway. I’m sorry to have to tell those kindly people emailing me about how quantity surveyors are going to starve to death, that we’ll be ok for now, but thanks for taking the time to get in touch.

Plant & Equipment Depreciation Changes – 2017 Budget Measures

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The announced budget changes by the treasurer Scott Morrison, effectively take a sledgehammer to residential depreciation legislation that hasn’t really changed since 2006. The Reserve Bank only has a blunt instrument to work with, in changing the cash rate to curb/stimulate inflation, but fiscal policy can be far more nuanced. The Government opted against a collaborative and refined methodology in favour of whacking things with a big stick.

Whilst we patiently wait for the new legislation to be drawn up, I’d like to offer up some alternatives to simply disallowing plant and equipment deductions on anything but brand-new assets.

In listening to the speech, the Government was looking to achieve two things;

  1. A decrease in tax deductions for property investors; and
  2. A way to ensure that as a property changes hands, plant assets are not repeatedly claimed, and in some circumstances, the total claims on an asset are higher than its original value.

Point two can be a difficult one to comprehend, and at first glance, it seems like the investor is claiming inappropriately. However, I’ll explain that this is part of the tax legislation.

Let’s consider a low-value object that exists in isolation. It could be a door closer, a ceiling fan, or really any plant item with an opening value (or cost if you like) of $300 or less. So, let’s say an investor buys a brand-new house, and this asset is a $180 door closer. The investor is entitled to claim the whole $180 as an instant deduction. A door closer has an effective life of 10 years, but the ATO allows these items not part of a set with a value of $300 or less to be a 100% deduction in the year of acquisition. Now, this has been the case for a long time, but where this can potentially get out of hand is when that investor sells their property to another investor. Let’s say they held the property for two years, so they’re now selling the property to an investor as a two-year-old property. Now, this door closer is, of course, two years old. Having a 10-year effective life, it’s not likely to be functioning any less like the manufacturer intended after only two years of use. It also has a value! What is the value? Well, it’s not new anymore and has had some wear, so it’s not going to be $180 anymore. Quantity Surveyors don’t appear to have a uniform means of calculating a written down value, but that’s a whole different article.

Let’s say we give the door closer the exact same value it would have had if the previous owner depreciated it under the diminishing value method based on its effective life, rather than writing it off at 100%. That would give it a value as a two-year-old door closer of $115.20.

So a Quantity Surveyor completes a depreciation schedule for investor number two and provides them with a $115.20 residual value for their door closer. Then elect to write that asset off at 100%, as they’re entitled to. See the problem now? The total deductions on that asset have now been claimed to a grand total of $195.20. We’ve now made combined depreciation claims higher than the brand-new value of the asset!

Is this investor being dodgy, sleight of hand by Quantity Surveyors? No. It’s the ATO’s rule stating you do not need to know what the previous owner claimed on the asset.
I’ll grant you that my explanation was a lengthy one, but you’ll be pleased by the brevity of my solution. Scrap 100% deductions.

I’m not in favour of this approach, but it’s a way of achieving the aims of the Government as per points 1 and 2, without completely destroying depreciation on established assets.

 

Investors would still be able to claim the depreciation on the door closer, but at the appropriate effective life (which the ATO give as 10 years) which equates to a depreciation rate of 20% of the balance each year under the diminishing value method, or 10% of the opening value using the prime cost method. So, it would take 10 years plus to get the whole value, rather than straight away in the first financial year, but the deductions are there nonetheless.

 

As for maximising Government revenue, or rather minimising tax deductions for property investors, there was a change announced to plant and equipment depreciation deductions on the 10th of May, 2006. Yes, 2006 is not a typo. Again, this was another budget night change. Nobody seems to remember this, and maybe I’m the only true tax depreciation nerd left, but on that night, the Government changed the calculation for depreciation rates for the diminishing value method.
Some background, swift as I can for those falling asleep in the back. Of the two methods of depreciation, the diminishing value method is the most aggressive in the beginning and is overtaken only by the prime cost method after around 6-7 years. For this reason, most investors use it to get their deductions sooner rather than later. The way the depreciation rates were calculated for the diminishing value method was 150 divided by the effective life. So with the door closer it would be 150/10=15%.

On that fateful 10th of May 2006 budget night, the calculation changed from 150 divided by the effective life to 200 divided by the effective life. So carpets, like the door closer, went from a depreciation rate of 15% to 20%. With most investors using the diminishing value methods, and properties changing hands relatively frequently, this resulted in higher depreciation claims and less revenue for the Government. A solution to problem 1? Put it back. Make the calculation 150/Effective life again. This would still allow investors to claim deductions on second-hand assets but would minimise the loss in tax revenue. I’m not really in favour of this change, but as per above, it would be favourable to the announced changes.

 

These are just two ways that the Government could have tweaked the legislation without taking a big stick to it.  I’m not in favour of any changes that make things harder for investors as I believe rental accommodation is a crucial yet oft-forgotten component of housing affordability and reliance on Government pensions in retirement is far less favourable that self-funding your retirement through property investing. However, I yield to the economists far cleverer than I that say we need changes to depreciation to balance the budget, rather than tackling say, corporate tax evasion or the black economy.

These two suggestions are just what sprang to mind first, there is a myriad of other ways to achieve the implied budget aims without a blanket ban on plant and equipment deductions on established properties. If only someone would ask.

 

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