Well, the dust has finally settled on the new legislation regarding changes to the budget changes to depreciation that will apply to second-hand residential properties.
In this article we will dig deep into some of the questions we have commonly been asked since the 9th of May 2017, when the changes were announced in the Federal Budget.
Before we get into the nitty gritty let’s begin with a quick recap:
Property investors who acquire a second-hand residential property after May 10, 2017, that contain “previously used” depreciating assets, will no longer be able to claim depreciation on those assets. Depreciating assets, in this case, refers to things like ovens, dishwashers & blinds etc.
So let’s start with some of the easy questions we’ve been asked.
1. Do these new rules apply to brand new investment properties as well?
No, they don’t, if you buy a brand new property you will be able to carry on claim claiming depreciation exactly the way you have done so to date. That means you can claim both the plant & equipment and structure of the building.
3. Can I still claim depreciation on things like the bricks, concrete & windows etc?
Yes you can, provided the residential property was built after 1987 when the building allowance kicked in.
You will still need a depreciation schedule to calculate these deductions. This component typically represents approximately between 80 to 85 percent of the construction cost of a property.
4. Can I still claim depreciation on plant and equipment items if I buy them and have them installed?
Yes, you can, provided they are brand new or from 2nds World or the like.
However, if you buy a second-hand item off Gumtree, for instance, you cannot claim the depreciation.
There is now no other depreciable asset class where this occurs.
The new laws state that the item cannot be “previously used” in order for you to claim the depreciation on it.
However, if you buy a “previously used” lounge off Gumtree and put it in your office – you can claim it.
6. What if I bought a property prior to the budget and lived in the property until now – can I claim the depreciation?
If you bought a property prior to the budget and it is owner-occupied, and then you move out after 1 July 2017 – you will not be able to claim depreciation on the plant and equipment in that property.
The property needed to be income producing in the 2016/17 financial year.
Those items will be deemed to be previously used and caught in the net of the new legislation – even though you acquired the property prior to the budget. So, these changes are kind of ‘half-grandfathered’, if you ask me. If you did buy an investment property prior to the budget, I would recommend getting a depreciation quote now, more then ever.
7. What happens If I inherit a property – can I claim the depreciation on the plant and equipment as well as the building?
Well, you will certainly be able to claim the depreciation on the residential structure of the building, provided it’s built after 1987. So there’s no change there – and this covers most properties.
Whilst there is no specific ruling on the plant and equipment it seems to me that if you inherit a property with plant and equipment items contained within, they will be deemed to be “previously used” and you won’t be able to claim them.
This would, in my opinion, even occur if the person that you inherited the property from, bought the property brand new.
As I mentioned, there is little guidance on this topic so it might be best to check this with the ATO if this question is relevant to you.
9. Can I still claim depreciation on a property that I bought overseas?
The answer is yes, you can depreciate an overseas investment property… but there are a few key differences.
The first main difference is with regard to claiming the building allowance. With Australian properties, you’re entitled to claim 2.5 per-cent of these construction costs per annum, as long as the property was built after July 1985. The rate for overseas properties is the same – but the date is different.
Construction of an overseas property must have commenced after 22 August 1990.
So, if you want to maximise your depreciation benefits on an overseas property, look for a newer property built in the last decade or two.
The plant and equipment, such as carpets, ovens, lights, and blinds, can also be depreciated as they would be in an Australian investment property but now they will have to be brand new or not previously used.
10. What happens if I engage a builder to renovate my investment property can I still claim depreciation?
In simple terms yes – provided all the plant & equipment items that were installed were brand new. You will also be able to claim all the structural items installed such as kitchen cupboards, tiling windows etc.
12. Show me the numbers?! How much will these changes actually mean in terms of how much depreciation I will be able to claim moving forward?
Well in order to understand this – it’s best to examine 3 different scenarios:
An investor buys a brand new unit or house for $850,000.
As you can see from the above chart the depreciation amount you can claim if you bought the same property pre-budget or post-budget hasn’t changed.
That’s because a brand new property is exempt from these changes.
An investor buys a residential house or unit for $850,000 that was built in the year 2000.
As you can see from the above the depreciation allowances available have dramatically reduced in the early years now.
Towards about year 8 they level out and aren’t that different. This is because the pre-budget chart on the left-hand side still shows that you can claim the plant and equipment. Whereas the chart on the right-hand side shows how you can only claim the building allowance moving forward.
The key takeaway from this is: That the depreciation allowances on second-hand property built after 1987 are affected most in the first 5 years. After that – there’s not much difference.
An investor buys a residential house or unit for $850,000 that was built prior to 1987 – that hasn’t been renovated.
Well in this scenario it’s all or nothing! Pre-budget we, as quantity surveyors, would visit a property, regardless of its age, and re-value the plant and equipment items like carpet, oven etc. In essence, starting the depreciation process again.
The Government wanted to stop this continual revaluation of plant & equipment and this will be achieved by the new legislation.
As you can see from the chart above if you buy a property that was built prior to 1987, there will be no claim at all if the property is still in its original state.
Why? Well, the plant & equipment will be deemed as previously used, thus no claim applies and in order to claim the building allowance, the property has to be built after 1987.
However, this is very rare, as most properties built prior to 1987 have had some renovation to them, whether that be a new bathroom or kitchen and those costs are claimable.
13. Can I still claim depreciation on plant and equipment on my holiday home if I use it twice a year?
This is the biggest grey area of all the legislative changes in my view and one that will require further clarification moving forward.
The Government in the Housing Tax Bill Explanatory Memorandum states that if a property is used in an “incidental way” or “occasionally used” then your depreciation eligibility on the Plant & Equipment does not stop if you acquired the plant & equipment prior to The Budget in May 2017.
Incidental Use is described as:
“Use is incidental if it is minor in the context of the overall use and arises in connection with another non-incidental use – for example staying at the property for one evening while carrying out maintenance activities would generally be incidental use.”
Occasionally Used is described as:
“Spending a weekend in a holiday home or allowing relatives to stay for one weekend in the holiday home free of charge that is usually used for rent would generally be occasional use.“
It’s a bit vague, isn’t it?
Does one week a year over Christmas nullify your claim? What about if you stay for Easter and Christmas?
What does this mean for all the Airbnb landlords out there that claim depreciation but move in when times are quiet but acquired the property prior to the budget? They went into that investment doing the maths on being able to claim the depreciation on a pro-rata basis based on the tax laws at the time?
Now if they use the apartment for an unknown time they may be disallowed the depreciation deduction.
Strangely, this Memorandum, differs from the ATO’s website which was updated on the 15th of December 2017 which indicates that “Gail and Craig” who use their property for 4 weeks a year can claim the depreciation? “Kelly and Dean” would appear to be ok as well!
Whilst the Memorandum doesn’t give a time frame… it indicates that a weekend is OK…I would’ve thought 4 weeks would’ve been stretching it?! Who knows – pick a number????
This is at a time when the ATO wants to target Airbnb hosts and pro-rata any capital gain tax exemption that may be applicable.
Hopefully, sense will prevail and if the holiday home is clearly available for rent – like 11 months over the year – it’s still an investment property.
Dealing with your rental property post-budget change
Before the budget change investors were entitled to claim plant and equipment and building allowance, so long as the property was built post-1987 and the property had settled within 10 years of getting the depreciation report, even if they had lived in the property prior, post or during the purchasing of their depreciation report.
A common question regarding the budget change:
The other day I received an email from one of my clients asking me for some personalised advice regarding his investment property and depreciation report. He told me he and his wife had purchased their first home in 2011. It was not a brand new property, and between 2014-2016 they rented out the property with a full depreciation schedule, claiming all they were entitled to. At the start of 2016 they moved back in to their home, and are now looking to renting it out again.
He was wondering if they are still eligible to claim the original tax depreciation schedule they purchased in 2014, or do they have to adhere to the new government tax depreciation rules since the budget change concerning the plant and equipment on established properties.
I thought this was a great question, and wanted to ensure all of my clients and readers were aware of the significant changes to the way second-hand, previously used assets are now being treated moving forward from the budget change.
The changes outlined:
As of the Federal Budget Announcement on the 9th May 2017, the Government has disallowed depreciation deductions on items such as Ovens, Dishwasher etc. where they have been previously used.
Whilst these new laws are grandfathered and as such are only applicable to properties purchased after the May 9th announcement, one caveat exists: The property must be income-generating at some point between July 1st, 2016 and June 30th, 2017.
This meant, that even though my client had acquired the property before the budget, they were unfortunately ‘caught in the net’ because they were living in their property for the entirety of the 2016/2017 financial year. Due to this, those aforementioned items would now be considered ‘previously used’ and they wouldn’t be entitled to claim any further depreciation on them.
The explanatory memorandum issued by the Government is a bit ambiguous (if you ask me):
“The amendments also apply to assets acquired before this time if the assets were first used or installed ready for use by an entity during or prior to the income year in which this measure was publicly announced (generally the 2016-17 income year), but the asset was not used at all for a taxable purpose in that income year. “
It’s worth noting that these new rules only apply to residential properties. Commercial, industrial and other non-residential property are not included.
It’s also important to note that the way residential property investors claim depreciation on the building has not been altered. You can continue to claim the depreciation on the structure (all the bricks, concrete etc.) provided the building was built after 1987.
Information goes a long way when you’re buying an investment property in Australia. Without information, you can’t prepare for the negotiations. This is when you sit down with the seller to try and find the right price for your investment property in Australia.
However, the information you have isn’t the only weapon in your arsenal. There are plenty of other tactics that you can employ to get a good deal. With that in mind, we’ve come up with five hot investment property tips for beginner negotiators.
Tip #1 – Learn as Much as You Can About the Seller
You may think the state of the property market would make it impossible to negotiate a good deal. If property prices are going up, it’s easy to assume that all sellers you meet will ask for more money.
However, this line of thought doesn’t take the seller’s situation into account. You need to find out everything you can about the seller when buying an investment property in Australia. For example, do you know the reason why the seller is getting rid of the property? If not, then you need to find out.
Many people sell because they’re in distressed situations. They may be in financial difficulties, or need to sell quickly to fund a new purchase. You can use this to your advantage and negotiate a better deal. After all, a motivated seller is one who will listen to lower offers.
Tip #2 – Sweeten the Deal
This ties into our first tip. Sometimes, a seller wants something really specific, which will make your bid for their investment property in Australia more attractive.
Consider the following example. The seller is currently going through a divorce. It’s a heartbreaking and emotional situation, but they really need to sell their property before the divorce is settled. As a result, that seller may be looking for a buyer who can help them settle the sale quickly, so they can get on with the rest of their life.
That’s where you come in. If you limit the terms attached to the transaction, you can speed up the process. That gives you some leeway to negotiate a lower price with a seller who wants to get rid of a property quickly.
Tip #3 – Get Pre-Approval on a Home Loan
Sellers love serious buyers. If you enter negotiations knowing that you don’t yet have the money to make the purchase, you’re going to sour the seller to any offers you might make.
This means it’s best to get pre-approval on a home loan before you try to buy an investment property in Australia. Lodge your application and ask your lender to provide proof of the pre-approval.
You can then take this into your negotiations. Having pre-approval shows that you’re a serious buyer who wants to move forward. This will make the seller more willing to negotiate terms with you, which could be your pathway toward making a lower offer that saves you some money.
Tip #4 – Make the Right First Offer
The first offer you make on your investment property in Australia is crucial. Go too low, and you may insult the seller so much that he or she stops taking you seriously. Make a high offer, and you may end up spending more than you need to.
This is where your research is going to help. Find out how much similar properties in the same area are selling for. You can use this to get an approximate figure for the value of the property. Compare this to the seller’s valuation to ensure you’re both on the same page.
From there, you need to make your offer. It’s usually best to offer somewhere between 5 and 10% less than the seller’s valuation. This shows you’re a serious buyer, while giving yourself some wiggle room if the seller comes back to you with a higher figure.
Tip #5 – Don’t Mention Your Budget
Remember that your seller’s agent is going to try and extract as much information as they can from you. After all, they want to secure the highest possible price for their clients.
Talking to the seller’s real estate agent can offer you more information. However, it can lead to you giving away information that the seller could use against you.
The key is to not let the seller know how much you’re willing to spend. If they have that figure, negotiations are going to start at a much higher price than you had hoped for. Play your cards close to your chest, while still making offers that show you’re a serious buyer.
The 6 must-know takeaways from these budget changes:
For residential property, you will only be able to claim depreciation on plant and equipment items (ovens, dishwashers etc.) when you buy a brand new property.
You will still be able to claim the building allowance (bricks, concrete etc.) on any residential property built after 1987.
If you bought a property built prior to The Budget on the 9th of May, 2017 when the changes were announced, you are not affected in the slightest.
There is no change at all to commercial or other non-residential property.
If you personally buy any item for your property after the settlement you can still claim the depreciation on that particular item.
Perhaps the most interesting point: Whilst investors purchasing second-hand property can now no longer claim depreciation on the existing plant and equipment, they will have the benefit of paying less capital gains tax when they sell the property, by claiming any unclaimed depreciation as a capital loss.
Moving forward, property investors will have a choice of ordering a building allowance report only, a CGT schedule or a combination, from Washington Brown.
On Friday 14th July, the Treasury Office released a draft bill regarding how depreciation deductions on a second-hand property can be claimed moving forward. They also invited interested parties to make submissions.
It’s complicated, to say the least, so I’ve tried to simplify this Bill and the key points. Here are my 9 Key Takeaways from the Legislation;
If you acquire a second-hand residential property after May 10, 2017, which contains “previously used” depreciating assets, you will no longer be able to claim depreciation on those assets.
Acquirers of brand new property will carry on claiming depreciation exactly the way they have done so to date. This is great news for the property industry and the way it should be.
We suspected this would be the case and I believe the property industry can collectively breathe a sigh of relief.
The proposed changes only relate to residential property. Commercial, industrial, retail and other non-residential properties are not affected in the slightest.
The building allowance or claims on the structure of the building has not changed at all. You will still need a Depreciation Schedule to calculate these deductions. This component typically represents approximately between 80 to 85 percent of the construction cost of a property.
The proposed changes do not apply if you buy the property in a corporate tax entity, super fund (note Self-Managed Super Funds do not apply here) or a large unit trust.
This is interesting and I suspect a lot more people will start buying properties in company tax structures.
If you engage a builder to build a house and it remains an investment property, you will still be able to claim depreciation on both the structure and the Plant and Equipment items.
If you renovate a property that is being used as an investment, you will still be able to claim depreciation on it when you have finished the renovations.
If you renovate a house, whilst living it in, then sell the property to an investor, the asset will be deemed to have been previously used and the new owner cannot claim depreciation.
Perhaps the most interesting point: Whilst investors purchasing second-hand property can now no longer claim depreciation on the existing plant and equipment, they will have the benefit of paying less capital gains tax when they sell the property.
How? Well, in summary, what you would’ve been able to claim in depreciation under the previous legislation, now simply gets taken off the sale price in the event you sell the property in the future.
Here is an example of how this will work:
Peter buys a property in September 2017 for $600k, included within the property was $25k worth of previously used depreciating assets.
As they were previously used, Peter can’t claim depreciation on those items.
Peter sells the property in 2022 for $800k, which included $15k worth of those depreciation assets.
Peter can now claim a capital loss of $10k ($25k-$15k) for the portion that Peter has not claimed in depreciation.
SUMMARY OF THE PROPOSED CHANGES
In my view, the Draft Bill could’ve been a lot worse for both the property industry and the Quantity Surveying professions.
It will certainly address the integrity measure concern of stopping “refreshed” valuations of plant and equipment by property investors.
It may, however, create a two-tier property market in relation to New and Second-hand property.
You can see the ads now “Buy Brand New – We’ve Got The Depreciation Allowances”.
It will still be just as critical for all property investors to get a breakdown of the building allowance & plant and equipment values so you can:
Claim the building allowance (where applicable) and
Reduce the CGT payable when selling the property by deducting the unclaimed Plant and Equipment allowances.
The Quantity Surveying industry, just like the property development industry just breathed a huge sigh of relief.
I believe this integrity measure could’ve been better addressed and will be making a submission accordingly.
But it wasn’t a bad ‘first run’ by the Government!
P.S. If you purchased an investment property prior to The Budget, and it’s been an investment property the whole time, you are not affected and you should get a depreciation schedule quote now.
Peter: The attendance tonight is mind blowing. In the world of depreciation, this is very much the equivalent of playing to a packed stadium. So thank you all for your interest.
Tyron Hyde: Peter, I’ve never been more popular.
Peter: Yeah, well. That’s right. In the quantity surveying world, this is as good as it gets I think.
Tyron Hyde: Sure.
Peter: Look, as all of you know the federal budget announcement at 7:30 pm on Tuesday the 9th of May included proposed changes that will significantly affect the way property investors claim depreciation in Australia from now on. Please feel free to type questions in the question panel as we go, and we’ll certainly have a question and answer session a little later on, but for now, to talk you through the ins and outs of these proposed changes, I’d like to hand over to Washington Brown’s Director, Tyron Hyde.
Tyron Hyde: Thank you Peter. I just want to confirm you can hear me okay?
Peter: Yip, all good on this end. Yip.
Tyron Hyde: Okay, great. Okay so, firstly thanks for coming. I know you can be doing other things tonight like watching the Swans or the Sharks and you’ve chosen to come here and listen to a talk on depreciation, but if you’re a property investors it’s probably a wise decision, because in my view what’s about to occur in the property investor market, is huge.
There are big changes ahead and I think we need to understand that, but before I get into those I just want to have a quick vote or a quick poll. I’m curious, how many of you have actually bought an investment property prior to the budget on May 9, 2017? So Peter’s going to put up a quick poll and you can vote or answer “yes” or “no”, whether you did or not. That’ll be great. So I’ll just give a quick couple of seconds to do that. Thank you.
Now let me tell you, you’re the lucky ones because what you’ve entered into will not change. If you bought an investment property prior to the budget, you’re lucky because these changes will not affect you, but I’ll go into that a little bit further down the line. But there are changes ahead and we need to be aware of them, and as property investors, we need to strategize about how it’s going to affect our future investments because the budget had changed the game.
The investment equation is altered significantly since the budget and I’ll explain that more shortly, but before I do that, a little bit about myself. My name’s Tyron Hyde, I’m the CEO of a company called Washington Brown. We’re Quantity Surveyors and as Quantity Surveyors, we work out what things cost to build. A large part of our business is in the preparation of depreciation schedules. So we go out to the audience and we identify what the construction cost of the property was and what the final equipment that you buy in that property contains.
So, we give you a report that says you can claim certain amounts of deductions based upon the construction cost, and also what’s included in that property as well.
But in summary, as Quantity Surveyors, what we do is we work out what things cost to build, and the reason I’m here tonight was a ruling in 1997 called TR 97/25 and that identified Quantity Surveyors as being the appropriate body to estimate construction costs where the costs are unknown. It was a good ruling to me, because they identified that we’ve got a lot of work, but in the good old days i.e., let’s talk about the good old days.
In the good old days, roughly a month ago, what we’d use to do; we’d go out to a property as I said, and we would distinguish between the plant and equipment in the building and the building allowance, the structure of the building. Now the plant and equipment in the building are things like the ovens, the dishwashers, the carpets. Now, this is the stuff that’s going to wear out quicker. The other part of a report of depreciation schedule is what’s called the Division 43 allowance. That’s the building allowance. That’s the structure of the building, that’s the brickwork, the concrete, the windows etcetera.
Now in order for you to claim those allowances, the property has to be built after 1987. So what’s changed? Well, lots changed. What the government is proposing is exactly this. Now I often like slides with lots of images, but a couple of slides here you need to understand what the exact budget measure is. So let me highlight it here. Now, this is the budget measure, and I’ll read this.
“From July 1, 2017, the Government will limit plant and equipment depreciation deductions to outlays actually incurred by investors in residential real estate properties.” Now the key here is “actually incurred”.
Who actually incurred that expense? Was it the developer? Was it you? So what they’re saying is, if you buy a secondhand property, it’s guaranteed that if you buy a secondhand property, that oven in that property wasn’t yours. You didn’t actually incur that expense when you bought that depreciable item.
I don’t know who bought it, I don’t know who did, maybe the fairies bought it, but you as property investors didn’t actually incur that expense. So you can’t claim the depreciation of those depreciable items such as the ovens, dishwashers etcetera. Who wants some good news? Put your hand up if you want some good news. Me too. The good news is, it’s grandfathered. The proposed changes they’re about to make are grandfathered, and what that means is that if you bought a property prior to the budget, nothing changes.
Who wants some good news? Put your hand up if you want some good news. Me too. The good news is, it’s grandfathered. The proposed changes they’re about to make are grandfathered, and what that means is that if you bought a property prior to the budget, nothing changes.
The good news is, it’s grandfathered. The proposed changes they’re about to make are grandfathered, and what that means is that if you bought a property prior to the budget, nothing changes.
If you exchanged contract, let’s be clear on this if you exchanged a contract prior to the budget, nothing changes. If you’ve already got a report from Washington Brown, you continue to claim the depreciation exactly how it is. It’s moving forward from that date. So, if you did buy a property two years ago and haven’t got a depreciation report, now is a great time to get a report because you have the benefit of the old system. So if you did buy a property three years ago or two years ago, and haven’t got a report, now would be a good time to do that. You can actually amend tax returns to factor in that property that you haven’t claimed, so you can actually amend your tax returns for a
If you’ve already got a report from Washington Brown, you continue to claim the depreciation exactly how it is. It’s moving forward from that date. So, if you did buy a property two years ago and haven’t got a depreciation report, now is a great time to get a report because you have the benefit of the old system. So if you did buy a property three years ago or two years ago, and haven’t got a report, now would be a good time to do that. You can actually amend tax returns to factor in that property that you haven’t claimed, so you can actually amend your tax returns for a
So if you did buy a property three years ago or two years ago, and haven’t got a report, now would be a good time to do that. You can actually amend tax returns to factor in that property that you haven’t claimed, so you can actually amend your tax returns for a two-year period.
So, now would be a good time to get a report if you haven’t got one. What else is good news? Well, the other good news is this only relates to residential property. So offices, industrial properties, retail properties, there’s absolutely no change. This is only targeting residential property investors. The other good news is that
Well, the other good news is this only relates to residential property. So offices, industrial properties, retail properties, there’s absolutely no change. This is only targeting residential property investors. The other good news is that
The other good news is that there have been no changes to the Division 43 deductions. What does that mean? Well, as I said before, there’s two components of a depreciation schedule. There are the plant and equipment and there’s the building allowance. The building allowance is the structure.
So you can still continue to claim. If you’d buy a property today, you can continue to claim brickwork, the concrete, the roof, the scaffolding as shown in this image here, exactly as it always has been. But the issue is, and there’s a bit of confusion in the market and quite rightly so, as to whether these changes affect the new property, or is it just secondhand property? No one knows. I’ve been in meetings with other Quantity Surveyors firms and really, we are unsure. I’ve written to Treasury and asked them for their guidance as to whether new property can still continue to claim the depreciation of plant equipment, and I got the usual response, “We’re formulating this budget measure …”
That’s not good in my opinion because there’s a lot of people out there now buying property, brand new property, and not knowing the full impact of what their depreciation claim will be and no market likes uncertainty. Now the reason there is uncertainty is because of this. Let me read the budget statement again.
“Acquisitions of existing plant and equipment items will be reflected in the cost base for capital gains tax purposes for subsequent investors.”
Now the key is here “existing plant and equipment items”. So it’s pretty clear if it’s a secondhand property it’s an existing item, but what about if I’d buy a brand new property that’s being finished, but it’s two weeks old, is that an existing plant and equipment item? You tell me.
What happens if I buy a property off the plant and it hasn’t even been built yet? Is that existing because I’ve entered into a contract to do that? What happens if I flip that property in three years time, who can claim those existing plant and equipment items? It wasn’t clear in saying brand new property’s okay, a secondhand property is not and that’s why there’s confusion in the market.
The bad news, boo! Who wants the bad news? No one wants bad news. The bad news is definitely for a secondhand property, the way the budget statement is written and possibly new, not yet sure, but definitely for a secondhand property, you will not be able to claim depreciation on things like ovens, dishwashers, lights, air-con, television sets, blinds, carpets, all those depreciable assets.
If we’re talking about a high rise apartment here, we’re talking about the common property items that you cannot claim as well and that might be things like the lifts, your portion of the lift, your portion of the smoke detectors, your portion of the common carpet in the hallway, garage motor doors, all right. So all those kind of equipment items will in the future be part of the cost phase. Who wants some great news? We all want great news. The great news is, you’ll still need a QS, said that with a smile, but you’ll still need a Quantity Surveyors because in order to claim the building allowance, you’ll still need to work out what the actual cost of construction of the structure is, and that’s where we come in.
The problem is that it’s going to be less. So let’s put this into perspective all right. When you build a house, roughly probably about 15% … I said 80/20 there because when I went to iStock, there was no 85/15 rule, but approximately 15% of the construction costs of a unit or a house relates to the plant and equipment of a building, that’s the ovens, dishwashers et cetera. The other 85% relates to the construction cost of the structure of the building. It’s got a massive difference in the overall claim that you’ll be able to make over 40 years. The main difference is in the early years, and that’s when a property investor needs those claims.
Here are some charts showing what the difference would be. So let’s say you buy a brand new unit today for $850,000. Pre-budget, your first-year claim will be about $20,000. Today, post budget, if your property is not allowed, will be about $9000. The second year $17,000, the second year post budget $9000. You can see here on this chart by about the eighth, ninth year, it’s getting very similar but it’s in the early years where the big difference is and that is when an investor needs it. See after 10 or eight years, the rent’s gone up and it’s not as crucial to getting those big deductions. Now let’s look at another scenario. If you were to buy a property built in the year 2000 that cost $850,000, today or pre-budget you’d get about a $15,000 year one deduction. Post budget you get about $6000 in my opinion. It’s about a third.
Again, year two $13,000, year to now, about $6000. The big difference is up front when you need it. About in year eight, year nine, it’s very similar, but again it’s the early years when and investor needs that to make it affordable. Now let’s look at a property built in 1986, and as I said before, a property has to be built after 1987 in order for you to claim the structure of the building. So, in this case, a property built in ’86 will get you $0 now if it has had no renovation. Pre-budget you might be able to claim $6000 in the first year, second year $3,000 and that relates to the plant and equipment, but because post budget you can’t claim the plant and equipment, there’s zero.
In my view that’s not going to occur a lot because most properties built before ’86 has had some renovation on it. It’s very hard to rent out a unit that was built in, say, 1980 that hasn’t had some capital improvement on it, new kitchen, new bathroom tiling, etc etcetera. So this is a bit of an exaggeration because most properties built before ’86 have had some capital improvements to them, but it highlights the difference between a property built before ’86. Now, why is the government doing this?
There are a couple of reasons in my view. The first reason, as the budget statement says is, “This is an integrity measure to address concerns that some plant and equipment items are being depreciation by successive investors in excess of their actual value.”
You know what? I agree with them, a 100% agree with them. The reason is, there’s hasn’t been a lot of legislation or guidance on how you actually value second-hand plant and equipment attached to buildings, attached to land. Let me give you an example of this, and this actually occurred … I’m sitting at 321 Pitt Street right now and last week a unit in our block, in our Strata building here, sold for $600,000. The next day, someone came along and gave that guy $800,000 check to take it off him. So he made $200,000 in one day. Now, how do we as Quantity Surveyors value the carpet that was sold with the $600,000 purchase and then the next day, value it when someone bought it for $800,000?
In theory, even though it was a day, the carpet depreciated and because someone paid a lot more for it, didn’t they just pay a bit more for that carpet that was situated in that suite? I would argue “yes”. Now, this is a very different scenario to the building allowance because the building allowance and the structure of a building are based upon its actual cost. So it has no bearing in relation to what the purchase price was, but plant and equipment are based on what you pay for it. That’s the confusion. The other issue is to address housing affordability, and I agree that if you’re in Sydney or Melbourne right now, not in a lot of parts in the country, but in Sydney and Melbourne right now if you’re on a medium wage it’s pretty hard to get into the market no doubt.
I’m not sure though if these measures are the correct way to address housing affordability, I’ll go through that shortly. So will it work? Well, if you ask me, the government’s got themselves into a pickle. There is a fork in the road, as I’ve shown by this fork and pickle, that they’re going to legislate this two ways and I do truly believe that when this budget statement came along, there was a lot of people in the ATO saying, “How on earth do we legislate this?” So there are two paths they can take now. One is to allow new a property to be depreciation and then the second purchaser thereafter can not, or all property, new and secondhand property, can not claim the plant and equipment as a depreciable asset.
So let’s look at these options. So if they say that new property’s okay, well, don’t you think that near new property will struggle to sell? Say I want to buy a property, if the developer down the road is selling a brand new unit and he’s saying, “I can get you $20,000 in depreciation” to someone who’s got a similar unit nextdoor that’s two years old and there’s far less depreciation, I suspect that those people that have got the secondhand property would struggle to sell that. That worries me a little bit because I know there’s been lots and lots om mums and dads have been advised by their financial planners to take money out of their super fund and to buy this brand new unit. If they need to sell that in a couple of years time, a two-year-old property, in my view they’re going to struggle.
I think people will hold on to their property, don’t you? If I bought that brand new property three years ago and I’ve just seen that the law has changed, and if I go and buy another property, I can’t get the same depreciation allowances, I suspect that people will hold onto it. Now I’m not a great economist, but I do remember one thing about economics and that price tends to be a factor of supply and demand, and if there’s less supply in the market, prices could go up. I don’t know how that’s going to affect affordability. The other thing is, do you remember the Vendor Tax? I don’t know how many of you are here in New South Wales, but about 15 years ago, the state government in their wisdom here, decided to introduce a Vendor Tax on property, which was, in essence, a stamp duty on the way out.
It was about two and a half percent and they said, “Well, we’re going to slug you, two and a half percent of the sale price of the property when you sold it.” Guess what everyone did? They held on to their property. The revenue forecast for that was a quarter in the first year and they didn’t get the stamp duty, they didn’t get the forecast on the Vendor Tax, so seven months it was around and then they squashed that and said, “This doesn’t work.” I can see the same thing happening here. Let’s look at their other option. That all property, there’s no depreciation on plant and equipment. Well, if new property can’t be depreciation for plant and equipment, in my view, developers will struggle to get presales.
You know, when a developer is developing a block of apartments, they need presales to show the bank that this is a good job from a financing point of view, and in a lot of the way they do that is by getting investors to buy early on and they do that by mathematical modelling and a big part of that is in depreciation deductions. If they can’t get that, they won’t get funding so obviously they’ll struggle to get off the ground because not a lot of people say, “I want to buy that unit. In three years time I want to live there and be an owner occupied property” because things happen. Some of them get married, some have kids. The owner occupied market is more closer to the event, whereas investors can do the mathematics on it, hope the property goes up, know they’re going to get these depreciation deductions etc cetera..
So, that could limit supply, which again, how’s that going to help affordability? I don’t think it’s going to. And again, people that have already got property, will hold onto their property because they know that if new and secondhand property can’t be depreciated for their plant and equipment decisions, I’ll just hold onto it. It’s like what happened with the Vendor Tax in my view. I don’t think there’s been a great cost benefit analysis of this proposed change. This is from the government, this is from the budget statement. Their forecast, Treasury’s forecast over the three year period, they’re going to save $260 million from this, over a three year period.
How on earth they got that number is baffling to me, but in the overall scheme of things, I don’t think they’ve weighed up what the risk of changing people’s mentality of how to buy and sell property is. You see, there could be a loss of revenue in Capital Gains Tax. If some people at the moment though, “Well, I think the Sydney market or Melbourne market has peaked and I’ve made a half a million dollars on it” they might sell because they might think, “Well, you know, I can continue to claim these deductions.” Maybe. If they don’t sell and they don’t go a buy another one, well, they might be less stamp duty, or they can’t get into that new property because there’s less deductions, there will be stamp duty loss.
Another aside is this. If new property can’t be depreciate as well, well then construction activity will slow down. The Housing Industry Association says that for every $1 spent on a construction job, $10 filters through the economy. Now I know they HIA is quite pro property, well let’s assume they’re half right. It’s a big risk/reward scenario just to save $40 million in carpet deductions I the first year, if you ask me. Houston, we have a problem. Now I look at this from a technical point of view, because I’ve been dong this for 25 years and I can see how this actually works in terms of what we do as Quantity Surveyors and I think there’s some problems and some things that have not been thought out.
When I’ve been giving these talks, a lot of people say to me, “Well, I’m just going to split the contract. I’m going to buy a unit or engage a builder and say, ‘Well, just have the plant and equipment separate’ and then I actually buy that stuff” and that could occur. It depends on the legislation as to how that actually occurs, but I think the government will say that if [inaudible 00:22:50] at the time, it’s part of the property. I don’t know, but already whenever I’ve given these talks, people were already trying to work out how they can get around it without any legislation being written. I don’t think that’s a very good system that we’re going into.
Another issue is, let’s say a new property is allowed to be depreciation, what happens if I buy a brand new property, I live in it for five years, I did apply that, but then I moved out, can that person claim it? I’m not sure. Now, this is the trickiest one to me and I guarantee no thought has been on this. What happens if I buy … because as I said before, commercial property can be depreciation, but residential can’t. What happens if I buy a property that has a doctor suite or dental suite at the front or a retail space and has a retail down the bottom and a residential probably at the top?
So in that scenario, we can have the same carpet at the top, the same carpet down the bottom at the retail or the commercial space and the carpet downstairs is okay, but the carpet upstairs is not. We could have system where deducted air-conditioning goes throughout the whole building, but half of it is okay, half of it’s not. Then, when you sell it, you’d have to somehow split the capital gains cost base into the two and you could have a control system that’s just in the residential, but not in the commercial and I don’t want it there. Not a lot of thought in there if you ask me. So, I can see a CGT nightmare coming along with this, quite frankly, particularly in those areas where there are multi faceted buildings.
Here’s another thing. What about the building contract? What happens … so it says here, so if the plant and equipment is actually acquired by you. So if I engage a builder to build a house, could I acquire that plant and equipment, or do the builder? I’m not sure. I would assume where I’d engage a builder and having a building contract, I would actually acquiring that plant and equipment, so it would be okay. That’s an assumption, but that would be a different scenario to where a developer built a block and you buy it new. What I would think that moving forward, if you actually engage a builder
What I would think that moving forward, if you actually engage a builder to build a property for you or renovation, then you’re actually as part of that building contract, acquiring the plant and equipment within the building contract.
If not, again, people that I’ve spoken have said, “Well, I’m doing a renovation, do I need to split out the plant and equipment now, have that as what’s called a plant cost item, and acquire those items myself?” Seems a lot of work for the minimal reward that the government gets. So, I’ll stop talking about the problems. What the solution? Well, I’ve been involved with some meetings with the Australian Institute of Quantity Surveyors and some other CEO’s of leading firm and it’s quite simple if you ask me, and in reality it probably sort of what’s always occurred. That is, I’ll give you an example. So in my view, the plant and equipment item within a building should be based so the original purchase should be able to claim the depreciation item.
What’s the solution? Well, I’ve been involved with some meetings with the Australian Institute of Quantity Surveyors and some other CEO’s of leading firm and it’s quite simple if you ask me, and in reality it probably sort of what’s always occurred. That is, I’ll give you an example. So in my view, the plant and equipment item within a building should be based so the original purchase should be able to claim the depreciation item.
So that’s in this scenario here, I’ve got carpet here as a good example. At the opening day of a brand new unit, the carpet was $3000 and it was sold after 5 years. The costs to that second purchaser should be about $1500 because it’s gone through half its effective life. This carpet has an effective life of 10 years. So the value should be around $1500 and that reflects the historical cost of the carpet, and that’s what we do now with brickwork and concrete and the structure. We look at what it originally cost to build, and I think the same thing should happen with carpet. Similarly, if the property when I bought it was 12 years old and the carpet had a 10 year effective life, when I buy it today, it should be zero, because it’s already passed its used by date.
At the moment, we look at the carpet and we’ll say, “Well, based upon the purchase price you’ve paid XYZ for your carpet, even though it’s 12 years old.” I think this would address the government’s concern that investors are claiming successive amounts higher than they should be, and I agree with that. That would address that, but also I think this will be able to meet the budgets forecast measures. I think it’s a logical solution. As Quantity Surveyors we’re also trained to look at this stuff and there’s a system in place to implement that, and this would also not disrupt the new property selling market and the construction activity.
So we, as an institute and other learned colleagues, have written to everything politician, senate and lower house, suggesting this as a method that will not disrupt the property market. Here’s hoping. Can’t guarantee it, but it would make logical sense to me. Now Peter is going to run a poll, because I’m curious … look, I’ve got my views on this topic and I think … well, I’ll let you decide. We want to run a poll. We did this at lunchtime today and we asked people what they thought of this. So basically we’ll run a poll now. Poll’s open, I can on my screen and the poll is, I want you to answer … and we’re going to send these results to you tomorrow.
The question is, “Do you think limiting the amount of depreciation you can claim when purchasing a new property will help housing affordability?” So I’m just going to let you vote on that for a second, and as I said, we’re going to send you the results tomorrow. Is that right Peter?
Peter: Yeah, along with as special offer for attending the webinar too.
Tyron Hyde: Great. So let me know when we can go to the next slide? You know I chose this even though it’s got the American flag. Just thought he was really cute and just though I’d like him in there.
Tyron Hyde: All right, let’s move to the next one. I hope you voted on that, thanks. Now I wrote a book called “Claim it”. It’s very relevant today, because a lot of it talks about my property investment journey and property investing in general, but obviously parts of it might be a little bit outdated thanks to the budget. So I’ve been approached by my publicist to write another book and I need a new title.
Peter: I’d like to remind everyone that this was also a bestseller, isn’t that right Ty?
Tyron Hyde: Absolutely it as a best seller. I think it had to reach 7000 sales to be a best seller, but the fact that my mother bought 4000 copies is absolutely irrelevant. The wonderful thing about when she did that Peter, was she read it, she said, “Well Ty, that’s great. I actually know what you do now” which was wonderful. So some of the titles been bantered about are “Claim it 2”, “Keep claiming it”. My favourite so far is “Claim it 2, electric boogaloo”, but I would like you to recommend some. One of the ones at lunchtime today was, “Claim it 2, the demise of Scott and Malcolm” along those lines, but if you can suggest a title, that will … you never know, you might have a book named after you. So wonderful. I will send you a signed copy of that. We’re also going to, Peter, send a discounted rate to people after this webinar. Tomorrow I believe.
Peter: Yep, so look out for that tomorrow.
Tyron Hyde: Now I’m going to throw some questions. Whenever I’ve given this talk, I’ve had some fantastic questions. When I gave this talk in Melbourne last week on stage, but one guy put his hand up. He said, “Tyron, so what I’m going to do, is I own an old property, but what I’m going to do is I’m going to rip out all the carpet and the blinds and the dishwashers, all that plant and equipment stuff and sell it as a bare bones property, because then, when that new purchaser comes in, they can buy all those stuff themselves and claim the depreciation.” I thought it’s an interesting point.
So I was wondering if you guys and girls have any questions that you’d like to throw at us? I’m not sure that I can answer it, but I’ll do my best, but because there is a little bit of uncertainty about this topic, I’ll certainly endeavour to do my best.
Peter: Well Ty, we’ve certainly got a huge array of questions here, which is fantastic and we’ll try and get through as many as we can. So we’ll jump right in. Similar question asked by Minlee and by Michelle and they’re saying, but purely from a depreciation maximisation perspective with these new rules in place post budget, “What type of property should investment property should I be looking for?”
Tyron Hyde: Well, that’s a good question. Firstly I’ll say that tax driven investments are not what someone should focus for. Obviously commercial, industrial properties you’ll still be able to claim depreciable benefits and building allowance benefits. Just like residential properties, you can still claim the building allowance, but to me, the investment focus of an investor or should not be about the tax driven benefits.
You should be focusing on other things such as the infrastructure, yields etc cetera, and then make the tax benefits work for you. Easier said than done, but that should be the focus but clearly commercial properties and industrial properties will still be able to reap the benefits of depreciable plant and equipment assets. The funny thing about this is, I think the government has targeted residential properties for this and in reality, let’s face it, they’re really targeting Sydney and Melbourne because someone who’s owned a property in Perth isn’t jumping up and down saying, I’ve got all these depreciation benefits when their property has gone backwards, right?
So in my view it is a Sydney and Melbourne kind of focus tax driven budget measure. The interesting thing about that is, I mean look at what the RBA is saying, they’re more concerned or as concerned about the commercial property market. Some of the yields that people are buying commercial property on at the moment, are ridiculous, but they’ve let commercial properties continue the way they are. That’s possible because there’s a lot of big players in commercial and if you were to tell Lendlease, so when they buy a shopping centre, they can’t claim the air-conditioning in their shopping centre, that would be difficult.
Peter: So potentially commercial property, who knows in the future whether they’ll shift attention to that too?
Tyron Hyde: Who knows? Who knows?
Peter: All right, I hope that answered that question guys. All right, so we’ve got a question here, obviously a good one, from Mark. Mark’s asking, “Do these changes apply to all scenarios of ownership for residential property, for example, is it the same for owners whether they’re an individual owner, a joint owner, a company, a trust, a super fund?”
Tyron Hyde: Great question Marc, it’s something that I haven’t thought about, to be honest. It does. It clearly just says it’s residential, not the structure that you own it in, but it’s a really good question. I never thought about that, but the differentiation is not the entity that you own it in. The differentiation is that it’s residential property. So the answer is I don’t think it matters when you own in a trust fund or super fund, it’s clearly written that it applies to all residential properties, but a good question.
Peter: Yeah, I thought so too. All right, Jayni is asking, “When we talk about property purchased before Tuesday, May 9th, when these changes were announced, do we mean settlement date or contract exchanged?”
Tyron Hyde: Definitely contract exchanged. So if you bought that property prior to … if you exchanged that property, but you settled today, you’re okay. We had a client last week, ring us up in a panic saying, “I exchanged on the 9th of May. What kind of reporting can I do?” And we said, “Well, you’re going to have the old good report. You’ll be able to claim both plant and equipment and the building allowance, provided that you exchanged before 7:30 pm.”
Now most people do, but sometimes it does occur later, but we said, “As long as you’ve got some email correspondence from your lawyer that this occurred prior to 7:30 pm, which is when the cutoff hour is, you’d go into the older system and be fine.” So it’s definitely on exchange, not on settlement and on that note, if you entered into a building contract the same applies. It’s not from when handover is, it’s when you would’ve signed that building contract, so when you entered into that building contract would be the applicable time, not when the building was handed over to you.
Peter: Right, okay. Thanks for clearing that one up. Okay, we’ve got a question from David. David’s asking, “I bought my investment property three years ago and have never had a depreciation schedule prepared. Can I get one now, and how many years back can I claim?”
Tyron Hyde: Absolutely you can David. So you’re in that boat where I said before, that this is a golden opportunity for you. What we will do is we will based that report on when you settled on that property. You’ll get a report that says from us that you settled in 2014 and those deductions will start from that day. You can then amend … you know, you need to speak to your accountant about this, but … maybe not your accountant, but as far as we’re aware you can amend your tax returns for two years.
If you’re up to date, you can amend two years back. If you did your last tax return 2015, you can go back to 2013, but again we’re not accountants and you need to discuss that with your financial advisor, but that’s the advice we get from many different firms.
Peter: All right okay, great. We’re getting some really fantastic questions here. Vicky’s asking, and I think it must relate to one of the graphs you showed, the comparison chart. She’s saying, “Is there a reason that the pre budget side uses are diminishing value method and the post budget changes side use the prime cost?”
Tyron Hyde: Vicky, you get a Cutie doll, very clever question.
Peter: It’s a good one.
Tyron Hyde: The reason is that because in the post budget … so in the pre budget, the plant and equipment can be claimed by the diminishing value method and the prime cost method. Post budget, if all we’re talking about is the building allowance, you cannot claim the building allowance via the diminishing value method. It has to be claimed by the prime cost. So very impressed with that question and it wasn’t a typo. So pre budget you’ve got the allowances thereof 20k the first year for the brand new property.
Half of that would be prime cost, which would be the building allowance, the other half would be the diminishing value method, which would be the depreciation of the plant and equipment. Moving forward, if there’s no depreciation of the plant and equipment and it’s part of your CGT equation or part of the cost base, and all you claim is the building allowance, you don’t have a choice to claim the building allowance under the diminishing value method. All you can do is claim that under the prime cost method, so very good and well spotted Vicky.
Peter: And Ty, that’s because it’s at a set rate and therefore the same each year, isn’t that right?
Tyron Hyde: Correct. So the building allowance is a set rate of two and a half percent over a 40 year period, which is why it’s slower. It’s a fixed rate. As an example, if the structure of the building costs $200,000 today to build, you get to claim that at two and a half percent over a 40 year period. So each year is five grand, five grand, five grand, whereas the ovens and dishwashers all have varying rates of depreciation, all have varying rates of effective lives and so it’s a very different scenario and those plant and equipment items we can claim using the diminishing value method, or you can use the prime cost method on that. Complicated, I know, but well done Vicky.
Peter: Good question. Ty, Lisa is asking, “If we already own a unit and we renovate, say now, after the budget, are we entitled to claim any scrapping allowance? Any residual value and can we claim depreciation on the renovation, the new items we’ve purchased?”
Tyron Hyde: So Lisa owned that property … hi Lisa. You own that property prior to the budget, was it?
Peter: Correct, yeah.
Tyron Hyde: Yes you can. So the scrapping of the residual value, again, if you’ve bought the property prior to the budget, there’s no changes in what you can do in terms of removing items and your original claim is not altered. If you removed items from a property you already owned, you would still get a balancing adjustment of that, there’s no different here because those plant and equipment items do not form part of your cost [inaudible 00:41:57]. It’s a different CGT equation. Another example, say I bought a property prior to the budget, say I bought it in the year 2015 and I renovate that property today, the question there was also asked, “Can I claim the depreciation of the renovation if I bought it prior to it?”
The answer’s yes, the budget statement clearly says that if you bought a property prior to the budget and you then go and replace the oven and depreciation that oven, you can claim the depreciation of that oven. What it does also clearly say is that the purchaser after you cannot.
Tyron Hyde: And that’s were a little bit of confusion is in terms of where it words the subsequent investor. So it clearly says that a subsequent investor cannot claim the depreciation of the plant and equipment, which had let a lot of people to think that new property’s okay, but I’m not reading that way. To be honest, everyday I change my mind. I think, “Ah, they’re going to allow new. Ah, they’re not going to allow new.”
There’s lots of reasons why I could argue both reasons as to why they will they won’t and I can go on all night about that and the answer is, I don’t know.
Peter: It’s frustrating, but I guess we have to have a definitive answer and clarification from the Treasury office as of, what, the 1st of July.
Tyron Hyde: Absolutely. In reality, it should’ve occurred already. It should’ve occurred already, because right now people … as you know Peter, we produce reports for the developers and with say … and we’ve done this since the budget, we’ve said they want to know when they’re selling property, how much allowances they can show potential investors, they can in depreciation, right?
So there’s people out there right now, with marketers and developers saying, “Based upon our forecast and you can get a $15,000 depreciation deduction year one” and they can enter into that contract and then, in three weeks time, they’ll have to go back and say, “Sorry, it’s going to be $6000” and I think it’s quite shocking, quite frankly, that this uncertainty is in the marketplace.
Peter: Yeah, I agree. Very frustrating. Okay, another question if you’re happy to keep taking them. I’ve got one from Veronica. Veronica’s saying that she’s owned her property since well before the budget changes and it was her principal place of residence and now post budget changes, she’s going overseas for an extended period of time and the property will now become a rental. Will she be able to claim the depreciation on the plant and equipment items?
Tyron Hyde: Great question. As I said before, I will be hoping to answer all I could. I think you will be okay. I think that the legislation will look at when you actually acquired that plant and equipment and that was prior to the budget, so in theory it should be okay. I’m not going to bet my last dollar on that, but I think that would be okay. I think that anything prior to the budget, you’d still be under this grandfathering law and the law should still apply to you. It’s a good question, but I think you should be okay.
Peter: Yeah, so I guess Ty, the take away from that is where we think that it will be relevant to when you purchased the property as opposes to when it became an income generating asset.
Tyron Hyde: Correct. Absolutely right. Far better word than me, Peter.
Peter: Well, I’ve had time to think about it. You’ve been speaking. All right. We’ve got a question here. Let’s take this one from Allan. Allan’s asking, “How does all of this affect negative gearing?”
Tyron Hyde: Wow, okay. Good question. So if you ask me, okay, let’s think about negative gearing. So what most people know about negative gearing is that you can claim the losses of the property against your taxable income where there is a loss. Now the interesting thing about this is that, in the current interest rate environment, up until two years ago, most people were getting a 5% yield on properties and as rates have come done to three and a half percent or 4%, well, there’s actually not a lot of negative gearing in terms of what the outlays of your mortgage are versus your rent until today.
I was at a seminar last week and the finance broker was saying they can still get 3.8% mortgage as long as you’ve got 20% equity in the investment property. So at 3.8% you’re getting rent, maybe not in Sydney, but in a lot of parts of the world because there are other places other than Sydney and Melbourne with who we’re getting 5%. Well, that’s not real negative gearing there, is there? In some ways I would say that what the government’s done, and it could be a brilliant political move, they have just sloshed negative gearing without telling anyone they’ve done it because the only thing that … if you look at what the deductions are for investment property owners.
There’s the mortgage, but there’s a lot of other things. So, when you’re reading the paper, “Property investors, they’re claiming $3 billion in negative gearing deductions.” If you actually drill into what the losses are, a lot of it relates to things like accounting, property management fees, rates, taxes. Now I can’t see a time where all those costs are not going to be deductible. That’s like saying when you buy a share that your brokerage fees are not deductible.
In reality, if rates are where they are and rents are where they are, the only thing that are pushing people into the negative gearing territory would be the depreciation of the property, because they’re never going to not let you, in my view, claim your property management fees or accounting fees. So as I said before, when the papers say, “There’s $3 billion in negative gearing losses” lots and lots of that relates to things that are not losses on your mortgage.
As part of that $3 billion figure, guess what one of them is? It’s land tax. So they’re saying that the losses of you paying tax on your investment property are part of the negative gearing equation. So in some ways I would argue that what the government has done, is squash negative gearing without telling anyone, because they said pre election they’re not going to stamp out negative gearing.
Clever. Clever in my mind I guess, but again I reiterate, I think the risk/reward ratio of what they’re trying to do, is far greater than what the reward they would have. I” just get off of my soapbox now Peter.
Peter: Ty, are you happy to take a few more questions that are still coming in?
Tyron Hyde: Absolutely.
Peter: All right. May have covered this before, but Yen is asking, “If I buy a new apartment, do I get the depreciation on the plant and equipment items, or does the developer?”
Tyron Hyde: No one knows, is the simple answer and that’s the big unknown. As I said, I change my mind on that all the time. Look, if the developer builds and develops the property, he’s gong to be able to claim the depreciation. If he then sells it to you as the purchaser, I would hope that you as a purchaser will be able to depreciate those plant and equipment items.
One of the reasons why I suspect that new property will not be able to depreciate as well, is because you could have the bizarre scenario where if someone buys a unit in a high rise block and owns it for two years and they can only claim that carpet for two years, that the next person who’s bought the same unit down the hallway, he owns it for five years.
He can claim the carpet for five years and there’s no other president in that scenario. That doesn’t occur in any other depreciable asset regime. It’s very unusual, so that tends me to think that they will say no new property cannot be claimed as well, but that’s why I think there’s to been a lot of thought in this because they probably went into this thinking that it’s only going to apply for secondhand properties, but then they thought about the mechanics of it, and thought, “How’re we going to do this?” and I’m waiting with bated breath to hear how they are.
Peter: Don’t know if they call that policy on the run, don’t they?
Tyron Hyde: I think they do. I think they do, and look, I think what’s happened is that the government had to be seen to be doing something against property investors. Rather than squashing negative gearing, this was their way of saying, “We’re trying to address housing affordability by limiting deductions on depreciation. We’re not saying there’s no negative gearing, but we’re going to do this” but I don’t think there’s been a lot of thought on the mechanics of it.
Peter: Well, time will tell.
Tyron Hyde: It will.
Peter: All right Ty, maybe one last question, and it’s a doozy I think. Leechen is asking, “If I buy a property built before 1987 today, there would be no building allowance to claim on. If the previous owners have conducted an extension of the building, am I able to claim on this?” And then second part to the question Ty, is, “How would I know if previous owners have done this?”
Tyron Hyde: So the first part of the question, it was an extension and it’s the building allowance component of it. Well, the laws haven’t changed in that regard. You can still claim the building allowance component of the extension regardless of these changes, because as I said before, the building allowance hasn’t been affected by that.
What might be affected is if there was carpet in that extension. That might be an issue, that would have to be worked out, but the structure of that renovation, there’s nothing changes because the building allowance component hasn’t changed.
Your second part of the question was, “How do we work that out?” You engage Washington Brown. That’s what we do. We go out to that property, because generally speaking, those costs are transferred over at settlement. So we go out to the property and we measure the areas and we look at what the structure is, we work out what the actual cost of the construction was.
Sometimes we don’t know when it occur, but we try to decipher when that renovation occurred and that’s what we write in your report saying … we say, “Well, the renovation occurred in 2000. The approximate cost was a $150,000 for that renovation” and the ATO, I will say generally accepts our view, but in 25 years they’ve never not backed one of our reports. So I’d say they do accept our view on that.
Peter: Yeah, right. And just to clarify there. You can start claiming the 40 years worth of depreciation available on those extensions from when we identify that they were put in.
Tyron Hyde: Correct. So if that extension occurred 10 years ago, Leechen would have 30 years, if he bought that now. Leechen, you have 30 years left of the claim left of the building allowance on that.
Peter: Even though there might only be 10 years left of claim on the original structure, for example.
Tyron Hyde: Well, there might be no claim on the original structure. So our report will say that there’s nothing on the original building, but the renovation of the property that occurred 10 years ago, you have 30 years left to claim that now. The new budget laws or budget proposal doesn’t affect that at all.
What might be affected, is the carpet within that renovation. This is where it’s all getting very, very interesting.
Peter: Well, I guess that’s a good segue to say stay tuned for the next web event when we get a little more clarification. We’ll certainly be wanting to share that with you all again.
Tyron Hyde: Well, that’s right. I think the amount of people that have come tonight and today, I think we’re definitely going to do an update of what’s actually occurred and look at other news of how we look at what people might do in the future shall we say.
Peter: Yep. Great. Well look, as Ty mentioned, again the attendance was fantastic tonight and you’ve all stayed online till the very end. I hope it was valuable. Once again, watch out for that email from us tomorrow, containing the link to request a quote and receive that exclusive discount and just to mention finally, if you have any questions about your specific scenario and depreciation, hopefully you can tell from tonight that we’re pretty passionate and a little bit nerdy about this stuff and we really love talking about it.
So if you do have any questions, please feel free to get in touch. One of our sales team would be happy to talk about your specific circumstances.
Tyron Hyde: And just finally, thanks for coming. It’s an interesting time that we’re all entering into. I’m going to keep … hopefully our clients and others abreast of these changes because it’s certainly is, in my 25 years of being at Washington Brown, in my view the most significant change that we as property investors are going to face.
Peter: All right, well once again thank you everyone for joining us and we look forward to being in touch soon. Have a good evening.
The property market is currently in a state of limbo, particularly those involved in the selling of new property.
Because budget statement in relation to helping “reduce pressure on housing affordability” has potentially changed the game and announced dramatic changes to the way depreciation is claimed on property.
Let’s start with the good news:
Any existing investment properties purchased (contract exchange date) prior to 7.30pm Tuesday, May 9th 2017 are not affected (unless they were not income producing in the 2016/2017 financial year – read more about the updated Budget changes here).
Commercial, industrial and other non-residential properties are not affected.
Capital works deductions have not been affected. This means you will still be able to claim depreciation on the structure of the building provided it was built after the 16th of September 1987. You will still need a Quantity Surveyor’s depreciation schedule to do so.
Now that we know what isn’t affected, let’s look at what has changed…
According to the budget statement
“From 1 July 2017, the Government will limit plant and equipment depreciation deductions to outlays actually incurred by investors in residential real estate properties. Plant and equipment items are usually mechanical fixtures or those which can be ‘easily’ removed from a property such as dishwashers and ceiling fans.”
Here’s the uncertainty….who actually acquired the plant of equipment?
Was it the builder/developer or was it the initial purchaser of the brand new residential property?
This is key.
Why is the government making these changes?
“This is an integrity measure to address concerns that some plant and equipment items are being depreciated by successive investors in excess of their actual value.
Acquisitions of existing plant and equipment items will be reflected in the cost base for capital gains tax purposes for subsequent investors.”
The industry needs urgent clarification on this matter! Why? Because many agents are currently advising potential buyers on the cashflow advantages of new property. This figures may prove to be inflated and put the developer or marketer at risk further down the line.
You see investors rely on these figures in assessing the merits of the investment.
Here is why I think this is dumb policy.
The proposed changes are being made to “reduce pressure on housing affordability”. In my opinion, it will have the opposite effect for 3 reasons:
Property investors may now feel they need to hang on to their existing properties in order to continue claiming depreciation. With these new changes, if they sell this property, they won’t be able to get anywhere near as many deductions on the next one.
Developers rely on high depreciation figures in the early years to show investors how affordable an investment property can be. If the allowances are taken away, they will struggle to get the pre-sales which are required by banks to fund the deal.
These budget measures are forecast to save $260 million over a 3 year period. I suspect far more will be lost if developers can no longer get new projects off the ground.
Whilst I believe housing affordability is a major issue, this truly appears to be an example of policy on the run…
Here’s the solution:
Plant and Equipment in residential property needs to run it’s natural course.
The ability to re-value and re-assess the item after it’s initial effective life has run it’s course should be squashed.
Put simply, if you a buy a property that is say, 11 years old, and it has a dishwasher installed that had an initial effective life of say 10 years you can’t claim it, revalue or re-assess it.
That would alleviate the government’s concern that:
“….that some plant and equipment items are being depreciated by successive investors in excess of their actual value. “
This would make a lot more sense in my opinion
I am looking forward to providing a further update once the legislation is finalised and I will give more details regarding the specifics of these changes when they come to light.