There are many considerations when purchasing an investment property. Property investors will need to consider their personal strategy, capital growth potential, rental yield, area demographics, rental demand, maintenance costs and much more. One important piece of the puzzle is property tax depreciation. It isn’t normally one of the first considerations of the property investor however it can exert a big influence on the overall cash flow, especially when you compare a new property to an older one.
We’ll take a look at a case study in a moment, but there are two key depreciation categories to consider, along their respective qualification dates.
The first component of deprecation is Plant and Equipment items, otherwise known as Division 40. Plant and Equipment covers things like Air Conditioning, Blinds, Cooktops, Curtains, Door Closers, Garage Door Motors, Garden Watering Systems, Hot Water Systems, Ovens, Range hoods and many other assets. These assets depreciate at different rates, but always result in higher rates than the building structure. The great news here is that no matter how old the property is, it will always qualify for Division 40 deductions. However, the older the asset is, the less depreciation there is likely to be available.
The next component is referred to as a Capital Allowance or Division 43. It basically covers all of the fixed components of a building structure and improvements to the land, including additions. Things like concrete, timber, tiles, retaining walls, bricks and most building components fall into this category. To qualify for this deduction, the property needs to have commenced construction after the 18th of July 1985. There are of course many investment properties that were built before this date, so is it still worthwhile claiming depreciation deductions through a tax depreciation report?
The short answer for the vast majority of cases is yes!
Often there are enough deductions in the Plant and Equipment items to make a report worthwhile, sometimes several thousand worth of deductions in the first few years of ownership. Another reason could be that there have been renovations or additions to the property. It doesn’t matter if they were done by the previous owner, you can still claim the value of the works. The majority of older properties have had kitchens or bathrooms updated since 1985, or at the very least a coat of paint. This is where a specialist Quantity Surveyor is required to estimate the cost of the improvement.
There’s no doubt that a newer property will always return more deductions than a similar sized older property, but let’s take a look at a case study to identify the differences.
Property 1 is a 160sqm brick and tile residence built this year, ready to be rented out on the 1st of July. The construction cost was $185,000 in total, which comprises of;
- $157,250 worth of building structure (Division 43) and;
- $27,750 worth of plant and equipment items.
The division 43 is easy to calculate as it is 2.5% of the opening value of $157,250, so $3,931.25 each year. The Division 40 items like ducted air conditioning, carpet, blinds and cooking appliances all depreciate at different percentages, for example carpet at 20% under the diminishing method. After the calculations, the deductions came to $4,162 on the plant and equipment items in the first year, making a total claim of $8,093.75.
Property 2 is a similar sized property, which was originally constructed in 1981. It was purchased this year ready for rental on the 1st of July. Prior to the current owner purchasing, the property had a few improvements and additions; an updated kitchen and bathroom, new carpet and blinds as well as a back deck. These items are a mix of division 40 and division 43. For example, the timber deck is Division 43 depreciable at 2.5% of its value each year, whilst the kitchen is a mix of Division 40 and Division 43. The tiled floor in the kitchen is Division 43, whilst the Cook top, Oven and Range hood are Division 40 and depreciate at higher rates.
The property has a few original plant and equipment items, such as light shades, door closers and room air-conditioning units. These original items as at the date of purchase were estimated by a quantity surveyor to total $945 and came out to $605 in the first year, with many assets totalling under $300, which enabled them to be written off at 100%.
The building improvements came to a total of $45,000, with $36,000 belonging to the building structure, and $9,000 belonging to the plant and equipment items.
The net result being a first year claim of;
- Building Improvements: $900
- Old Plant and Equipment: $605
- New Plant and Equipment: $1,350
Total Claim = $2,855
So as you can see here from the analysis, that Property 1 is the pick in terms of deductions. With $8,093.75 of tax deductions, compared to $2,855, resulting in a difference of $5,238.75.
However it’s important to note that the older property is still generating significant deductions, and would more than cover the cost of a tax deductible depreciation report prepared by a Quantity Surveyor, in the first year alone. There are of course extra deductions for back claiming, and the rest of the life of the property after the first year of claim.
Even where an older property is completely original, we often see several thousands of dollars worth of deductions on the old assets. It’s amazing to see the results of depreciation reports on older properties where the owner has been told by friends, family and even accountants that it’s not worthwhile paying for a report. We urge investors to contact a Quantity Surveyor to obtain advice on potential deductions. At MCG Quantity Surveyors, we can often tell over the phone, and will guarantee that if we cannot double our fee worth of depreciation deductions within the first full year, we won’t charge you.
As noted earlier there are a number of considerations when selecting an investment property. When it comes to depreciation it’s true that the newer the property the better, but the myth that older properties aren’t worthwhile is well and truly busted.