Getting your tax depreciation in order

What is a tax depreciation schedule? And what does it include?

As a property gets older and the building and the items within it wear out, property owners of income-producing properties can claim a tax deduction relating to wear and tear.

To claim these deductions, investors need a one-time tax depreciation schedule cataloguing the wear and tear expected on a specific property - and there’s no better time to get this in order than at EOFY.

Bradley Beer, the chief executive officer of tax depreciation quantity surveyors BMT, explains that a thorough tax depreciation schedule will include a number of important elements.

These elements include:

1. A detailed 40-year forecast illustrating all depreciable assets, fixtures, and elements of the building structure.
2. A summary of capital expenditure covering:
   • Division 43 Capital works deductions refer to the building structure including walls and roofs, as well as the assets permanently fixed to the building including windows, doors, and flooring.
   • Division 40 Plant and Equipment refers to assets that are mechanical in nature or are easily removable including air conditioning units, carpets, furniture, appliances, and other fittings.
3. Both prime cost and diminishing value methods of depreciation to help owners and their accountant decide which method is best for them.
   • According to Beer, both methods allocate the total depreciation of an asset over its useful life, but each employs different formulas for calculating depreciation deductions, resulting in varied short-term and long-term results for the investor.
   • The prime cost method of depreciation is also known as the straight-line method of depreciation. The prime cost method calculates deductions each year as a percentage of the asset’s cost. The result is that deductions are spread out over time with a more even claim each financial year.
   • The diminishing value method of depreciation, also known as the declining balance method, calculates deductions as a percentage of the asset’s depreciable balance. This means deductions are higher in earlier years.
4. All qualifying additional works completed by current and previous owners.
5. Low value and small business entity pools and instant asset write-off. Low-value pooling legislation allows owners to group qualifying depreciable assets in a pool which will depreciate at an accelerated rate.
6. A split based on ownership percentages, which can lead to higher deductions for owners in earlier years.
7. A pro-rata calculation for the first year of ownership based upon the property’s settlement date.
8. Depreciation for common property such as lifts and swimming pools where legislation allows.
9. A glossary of terms to help the investor to understand the terminology used throughout the schedule.

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How can having a depreciation schedule improve investor outcomes?

“Investors who use depreciation schedules will experience different cash flow outcomes in their property portfolios compared to those who do not,” Beer explains.

Depreciation schedules allow investors to claim tax deductions on the depreciation of their property’s building structure and assets. This can significantly reduce their liability, leading to higher after-tax cash flow.

The CEO says “investors with higher cash flow have more funds available for reinvestment, to pay down debt or for covering property-related expenses, potentially improving the performance of their portfolios.”

BMT finds owners of new residential investment properties an average first full financial year deduction of $15,234, and owners of second-hand properties an average of $8,925.

Beer notes, re-iterating how a depreciation schedule pays dividends beyond the immediate tax deductions.

“The additional financial benefits gained from depreciation can also help mitigate risks associated with property investment, such as vacancy periods, unexpected repairs, or market fluctuations,” he notes.

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When can (or should) investors invest in a depreciation schedule?

In Beer’s view, it’s never too early to consult with a depreciation specialist, with many new investors reaching out before they’ve purchased a property.

Once an investment has been acquired, Beer suggests owners should take advantage of depreciation deductions from the outset, pointing out that “depreciation can be claimed as soon as the property is genuinely available for rent”.

Beer says that depending on whether the building was new at the time of purchase determines when depreciation comes into effect.

“In the case of a newly built property, the investor can maximise the depreciation deductions available over the full 40-year life time of the property”.

“If the investor has bought a second-hand property there are two potential scenarios. In the first case the investor will be happy with the current state of the property and it will simply be put up for rent. It is a common myth that older properties will attract no depreciation claim. However, both new and old properties will hold some depreciation benefits. In this case the depreciation specialist will compile a depreciation schedule after assessing all the depreciable assets during a site inspection.

He warns: “Investors considering completing any work to their property should contact a specialist quantity surveyor before they start work. This is important during the removal or demolition of any existing structure or fixture onsite that would have been eligible to claim deductions for depreciation (Division 40) or capital works deduction (Division 43).”

Scrapping assets can entitle the owner to additional claims, and any remaining un-deducted depreciable value could be claimed as a 100 per cent deduction in the same financial year as the item’s disposal.

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When is a depreciation schedule useful?

Property depreciation is beneficial for both residential investment and commercial properties, including childcare centres, hospitals, restaurants, industrial properties, shopping centres, fitness centres and beauty salons to name a few, according to Beer.

He notes that property depreciation deductions are split into two categories, which apply across property types:

Division 43 Capital works deductions refer to the building structure including walls and roofs, as well as the assets permanently fixed to the building including windows, doors and flooring.

Division 40 Plant and Equipment refers to assets that are mechanical in nature or are easily removable including air conditioning units, carpets, furniture, appliances, and other fittings.

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Choosing an expert

According to Beer, the expert preparing your tax depreciation schedule will come with a specialist blend of property industry experience, including “a combination of construction cost expertise and knowledge of taxation legislation to concentrate on property depreciation”.

“Quantity surveyors are one of a few professionals recognised by legislation (Tax Ruling 97/25) to have the appropriate construction costing skills to calculate building costs for capital allowance claims. The ruling also states that accountants, solicitors, real estate agents and valuers are not recognised to estimate construction costs for claiming capital allowances,” Beer illuminates.

Membership with bodies such as the Australian Institute of Quantity Surveyors (AIQS) or the Royal Institution of Chartered Surveyors (RICS) is also important - with these memberships requiring ongoing professional development and adherence to industry standards.

BMT Tax Depreciation recently consulted on the AIQS’ introduction of a standard for ethical conduct and collaboration within the industry, The Quantity Surveyor’s Guide to Residential Tax Depreciation.

Promoting industry-wide consistency, preventing unethical practices, and ensuring the protection of clients, accountants, and quantity surveyors, it lays out a comprehensive framework for depreciation specialists to minimise risks.

To find out more about the industry leading work being done by BMT and how they can help you kick your EOFY goals, click here.