If you’re not already aware, last night’s budget announced some major changes to tax depreciation that will have a huge impact on quantity surveyors preparing depreciation schedules and residential property investors. I’ve been fielding calls and emails from accountants, investors and quantity surveying firm directors through the evening. There are two main ‘buckets’ of depreciation, there’s division 43 which relates to the structure of a building (concrete, timber, gyprock, tiling, cabinetry etc.) and division 40 which is plant and equipment items. Plant and equipment items are loosely described as items easily removed from the property without damage. Within a residential property, there are predominantly air conditioners, blinds and curtains, carpet, floating timber floors, ovens, cooktops, dishwashers, range hoods, hot water systems, security systems, smoke alarms and light shades. The list is quite long at around 150 individual assets, and apartment complexes will have a much larger list of shared plant and equipment items like lifts, fire indicator panels, swimming pool filters and the like.
The Government has just announced that there are now only two ways you’ll be able to claim depreciation deductions on plant & equipment items.
- You buy a brand new residential property*;
- You add the plant and equipment item directly yourself
This means that if you’re the second person to own a property, even if it’s only a year old, there will be zero depreciation deductions attributable to the plant and equipment items. This applies to residential investment properties where a contract was entered into from 7.30pm on the 9th of May 2017. If you’ve purchased an investment property prior to that date, you’ll be able to continue to claim plant and equipment items until the values either run out, or you sell the property.
What does this mean in real terms for the depreciation deductions for property investors?
Thankfully we’d already begun an analysis of our last 1,000 residential depreciation schedules, albeit for a completely different purpose. Nevertheless, here are some of our key findings;
- Of our last 1,000 schedules, 38.3% of them were purchased brand new and would be unaffected by the changes.
- 69.9% of the properties were built after the division 43 cut-off date of 16/9/1987, so there would be depreciation claimable on the original building structure
- Of all the properties built prior to the cut-off date, 63.8% have been renovated to some extent by the current owner. The average total value of this renovation is $39,191
So the key takeaway is that if we remove from the 1,000 figure, all the properties that would benefit from a depreciation schedule (built after 1987, renovated to a significant extent by owner or previous owner) we’re left with 161 properties that would not have sufficient depreciation deductions to warrant having a depreciation schedule completed.
In some ways that’s good news for the industry, as 83.9% of investors will still have some worthwhile claims (at least $1,000 per year), and arguably the market for depreciation companies has not been cut in half. My cut-off point for ‘worthwhile deductions’ for those older properties was the average post-purchase renovation figure of $39,191, which I also applied to prior renovations.
If we look at an average $39,191 renovation, our analysis tells us to expect around $3,278 of that to be plant and equipment. Since plant and equipment depreciate at higher rates than the building structure, that has a big impact on the deductions in total.
Our analysis shows a first full year depreciation breakdown as follows:
- Building Structure $897.83
- Plant and Equipment $956.18 (under the diminishing value method)
As you can see, removing the plant and equipment deductions cuts the deductions roughly in half. Our analysis is slightly on the pessimistic side as it’s feasible a 39k renovation could have zero plant and equipment.
So according to MCG Quantity Surveyors analysis, whilst there’s still going to be enough value to justify a depreciation schedule in 83.9% of cases, the total benefit of the schedule will be diminished. Over our 1,000 residential schedules analysed, the average first year depreciation deductions was $9,407.73. For pre-owned investments only, that figure drops to $7,484.35. It’s reasonable to assume that around half of that value will be gone within the first year. On a 37% marginal tax rate, the after tax increased cost of ownership of your average established investment property will be around $1,300-$1,400 per year.
We urge accountants to direct investors to quantity surveyors to analyse the potential claims and caution property investors not to panic.
Do I think the 83.9% is a solid figure? Sadly not. The concerns is that investors will not chase their entitlements based on poor advice or misinformation about their entitlements. On the basis of 69.9% of properties qualifying for division 43 deductions on the original property, this is likely going to be closer to the true cut to the depreciation business. Of course again, misinformation may amplify the problem.
It’s a massive hit to property investors, but mostly to depreciation companies such as ourselves. The budget speech championed the role of investors in keeping rents down and providing accommodation to millions of Australians. This measure will increase the after-tax cost of holding a residential property and that cost will either be passed onto renters, or the supply of affordable rental properties will drop placing upwards pressure on rents due to demand.
This is a disappointing development and I urge the Government to consider the clear majority of investors that are simply holding one investment in the hope of self-funding their retirement.
*Some developers and quantity surveyors are concerned that plant and equipment items on new properties might be excluded. Given the intention of the measures was to stop investors from repeatedly depreciating old assets on the event of each new sale, I cannot see this happening. If you buy a new property, the assets have never been depreciated so the deductions should be available.
Mike Mortlock is a Quantity Surveyor and 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