You Can Claim Tax Deductions in Australia for Previous Renovations
When considering tax deductions in Australia, most investors only take their own renovations into account. It does make sense. After all, why should you be eligible to claim deductions on your investment property in Australia if you didn’t pay for the work?
Perhaps surprisingly, you can claim deductions for the previous owner’s renovations. However, there are several things you need to consider. For example, how much you can claim depends on when you purchased the property. The effects of the 2017 Budget play a role here, as what you can claim differs depending on if you made your purchase before or after the budget. Let’s look at what tax deductions in Australia you can claim in both scenarios.
You Bought Before the 2017 Budget
Things are simpler if you bought the property before the 2017 Budget. If this is the case, you can make claims under both Division 43 and Division 40 of the Income Tax Assessment Act (ITAA).
Division 43 relates to any capital works that the previous owner undertook on the property. This includes any renovations, such as the building of some extensions or remodelling a bathroom or kitchen. It also covers any work done to the building’s structure. For example, you’d be able to claim for a new roof or for some of the walls that the previous owner built.
Division 40 relates to the equipment installed in the property. Your investment property in Australia may have an air conditioning unit or some other piece of equipment that the previous owner installed. If that’s the case, you should be able to claim for it.
The only real barrier is that you may not know the completion date for the work or the cost. Not all sellers will provide you with this information. If that’s the case, you need to employ the services of a quantity surveyor. Your surveyor will provide you with a cost estimate, which you can use when claiming tax deductions in Australia. The Australian Taxation Office (ATO) does not accept estimates from other professionals. For example, you can’t get an estimate from your accountant for the work. It has to come from a quantity surveyor.
You Bought After the 2017 Budget
This is where things get more complicated. You have to consider the extent of the renovation work, as well as whether any was carried out in the first place.
The new budget introduced the term “new residential premises” into the equation. To understand what this phrase means, we need to look at the Goods and Services Tax (GST) Act.
What Does the GST Act Say
You’ll find references to “new residential premises” in sections 40 to 75 in the GST Act. Generally, such a premises is one that has not been rented out or sold as a residential home before your purchase. This won’t usually present a problem. After all, that language basically covers new properties.
However, there’s more. The Act also defines these premises as those that have undergone “substantial renovation” work. The GST Act also provides a description for “substantial renovations”. They are any renovations through which the entire building has either been replaced or removed. As a result, the installation of a new bathroom is not considered as a substantial renovation on its own.
What Does This Mean for Me?
If your investment property in Australia does not fall into the substantial renovations category, you may not be able to claim the same deductions that you could on a property built before the 2017 Budget. In particular, you won’t be able to claim Division 40 depreciation. New equipment on its own is not enough to constitute a substantial renovation.
However, this changes if the building has undergone enough renovation to become a “new residential premises”. In such cases, you can claim for both Division 43 and Division 40 work.
You’ll need the help of a quantity surveyor to work out the extent of the work undertaken on your building. Your surveyor will create a timeline for the building. This will estimate the work carried out, its cost and its extent. You can use this information to figure out if your building falls into the “new residential premises” category.
Don’t fret if it doesn’t. You can still claim for Division 43 work. Your quantity surveyor will be able to provide more exact information detailing exactly what you can claim for.
You’ll need the services of a quantity surveyor, regardless of when your property was built. They will be able to tell you what previous renovations you can claim for.
We can help you if you’re looking for a quantity surveyor. Contact us today to maximise the depreciation on your property’s previous owner’s renovations.
Whenever I am delivering a presentation or conducting a webinar, I always make sure to leave time for a 30 min Q&A session at the end.
In most Q&A sessions, the topic that by-far receives the most queries has to do with the concept of “scrapping” in relation to property tax depreciation.
Claiming the Residual Value on items that are about to removed can significantly increase your tax depreciation deductions. The problem is that many investors who renovate miss out on this due to a lack of awareness.
It’s important to understand the basics of property depreciation before diving into the subject of scrapping so, let’s have a quick re-cap into what property depreciation is all about.
What is Property Depreciation?
Just like you claim wear and tear on a car purchased for income producing purposes, you can also claim the depreciation of your investment property against your taxable income.
There are two types of depreciation allowances available: depreciation on Plant and Equipment Assets and the Capital Works deductions.
- Depreciating Plant and Equipment Assets (Division 40) refers to items within the building like ovens, dishwashers, carpet & blinds etc.
- (NOTE: Deductions for these plant and equipment items may only apply if you bought the property prior to May 9, 2017 – They’re values, however, can still be scrapped in full if removed or sold- Read about the Budget changes here).
- Capital Works deductions (Division 43) refers to construction costs of the building itself, such as concrete and brickwork.
Whilst both of these costs can be offset against your assessable income, the property must be used for income-generating purposes. It is also important to note that to be eligible to claim on the Capital Works component, a residential property needs to have been built after the 18th of July 1985.
So what is scrapping and why is it a hot topic for property investors?
Put simply, scrapping is the ability to claim deductions on items within your investment property that you are about to throw away.
Engaging a qualified Quantity Surveying firm will ensure that you do not miss out on claiming any eligible residual value of these items as a depreciation deduction. This value can be claimed immediately in whole, once the items have been removed.
The reason it’s such a hot topic is due to the fact that these deductions can often add up to thousands of dollars.
There is one major caveat though. In order to claim the residual value on these items, your rental property must be producing an assessable income prior to the disposal.
There is no clear guideline on how long the property needs to be rented out for though, just that is was producing an assessable income.
There are two ways we can assess the scrapping allowances of an investment property.
Option 1 – Only depreciable assets can be scrapped
(This means the building was built before 1985 and no residual capital works deductions are available)
For Division 40 depreciable assets, if a taxpayer ceases to hold a depreciating asset (sold or destroyed) or ceases to use a depreciating asset (doesn’t need it anymore) a “balancing adjustment” will occur.
You work out the balancing adjustment amount by comparing the asset’s termination value (sales proceeds) and its adjustable value.
If the termination value is greater, you include the excess in your assessable income but if the termination value is less, you deduct the difference.
These deductions can add up quickly. Even if only in relation to depreciable assets.
Let’s crunch some numbers:
Joan Smith settles on a property for $650,000 on Oct 15 2015, the property had a long term tenant in place, who had agreed to stay for another 6 months. The property was 19.5 years old when she settled on it.
Washington Brown inspected the property on Oct 15 2015 and assigned the following values to the depreciable assets listed
Oven $ 625, Carpets $ 1536, Blinds $ 885, Range Hood $ 475 & Dishwasher $ 558
Joan decides, voluntarily, to upgrade the apartment so that she can attract a higher quality tenant. At the end of the lease, when the tenant moved out, Joan replaced the items above.
Joan can claim the full depreciable amount of $4079 in her 2015/2016 tax return for these items that she is removing.
In addition, Joan has spent $8,555 replacing the items above, she can now start to claim these new items based upon their individual depreciation rate.
Option 2 – Depreciable Assets and & Capital Works deduction can be scrapped.
If you start moving walls or replacing kitchens in buildings built after 1987: your claim has the potential to be huge!
And let’s face it, it’s not that unusual to want to update a 20 year old kitchen.
Now let’s crunch the numbers on a situation where Joan renovated the kitchen and bathroom as well:
|Capital Work item||Cost in 1995||Residual Value in 2015|
|Plumbing Bathroom & Kitchen||$6,375||$3,188|
|Electrical Bathroom & Kitchen||$4,750||$2,375|
|Tiling Kitchen & Bathroom||$8,750||$4,375|
The items above have been depreciated at 2.5% per annum for 20 years. That equates to 50% left of the value that can be claimed as an immediate deduction when removed in 2016.
That’s the tidy sum of $15,816.00 as an immediate tax depreciation deduction!
One thing that needs to be considered when calculating the amount of deductions available, is whether you or another person was not allowed a deduction for capital works.
“It’s complicated” but here the method statement from the Income Tax Assessment ACT:
The amount of the balancing deduction
Step 1. Calculate the amount (if any) by which the * undeducted construction expenditure for the part of * your area that was destroyed exceeds the amounts you have received or have a right to receive for the destruction of that part.
Step 2. Reduce the amount at Step 1 if one or more of these happened to that part of * your area:
(a) Step 2 or 4 in section 43- 210, or Step 2 or 3 in section 43- 215, applied to you or another person for it;
(b) you were, or another person was, not allowed a deduction for it under this Division;
(c) a deduction for it was not allowed or was reduced (for you or another person) under former Division 10C or 10D of Part III of the Income Tax Assessment Act 1936 .
The reduction under this step must be reasonable.”
So in simple terms, you need to take into account any periods where Capital Works deductions could not be claimed and reduce that amount from any residual value left.
The last line is interesting, “The reduction under this step must be reasonable”.
I say interesting, because there are so many variables and not a lot of rulings to go by. But in my opinions here are some reasonable examples:
- It would be reasonable to assume that if you purchased an industrial or commercial property, Capital Works deductions were available the whole time. So no allowance for non use would be required.
- It would be reasonable to assume that if you purchased a serviced apartment, Capital Works deductions were available the whole time. So no allowance for non use would be required.
- It would be reasonable to assume that if you purchased a unit in a ski resort, it was used, perhaps, for 2 weeks of the year for private use by the previous owner and you would need to factor that in.
- It would be reasonable to assume that if you purchased a holiday house, in area where holiday lettings are common and that you saw the property listed on AIRBNB prior to your purchase and the holiday period was blocked out – then you should factor 2 weeks of private use per year into the equation.
- Now the tricky one, you buy an average unit with a tenant in place. Who knows, it may have changed 5 times since it was new. I think it would be unreasonable for you to have to find out the full history of the unit. Privacy laws are very strict now, particularly in Victoria. So in that case, I would personally assume it was an investment property the whole time – but that’s me!!
One final thing you need to factor in, just to make life more complicated, is whether any amounts were received by way of insurance.
The termination value or residual value needs to include the amount received under an insurance policy.
So, if it is insured, there is often nothing to deduct when the asset is lost or destroyed.
As you have probably gathered by now, claiming the residual value on depreciating assets and capital works deductions “is complicated”.
I would recommend speaking with your accountant or financial advisor prior to engaging a Quantity Surveyor to carry out a scrapping schedule. If you are going to proceed with this type of report, it is advantageous to have the quantity surveyor visit the property prior to you starting renovations.
Time to spring in to action!
Don’t Forget Depreciation on Your Spring Renovation
I don’t know about you, but every time I see that sun coming towards spring– I start thinking “What can I fix up around the house… or who can I get to do it!”
But before your excitement gets you too caught up in painting your cupboard a crisp lime green, or thinking whether your wallpaper should have a touch of yellow or orange, it is helpful to remember the exciting benefits you may get with depreciation. After all, wouldn’t renovating be more rewarding if you knew that part of your expenses would come back to you through tax deductions?
How does it work?
When you renovate an investment property, you can actually claim particular expenses that you incurred as part of your renovation work. This includes the cost of that tile work you just did for your bedroom, or maybe that new edgy and urban kitchen sink. These things can actually get you a depreciation claim of 2.5% annum over a 40-year period. Even upgrading your plant and equipment items such as appliances and furniture also qualify for depreciation. Talk about claiming a reward for rewarding yourself! Where else can you get that?
2 Tips to get you excited this Summer
Property Tip 1
Scrapping reports – If you buy a property and are going to renovate the property, it’s worth getting a Quantity Surveyor out like Washington Brown, who will attribute values to those items that are about to be removed. This can add up to a substantial amount, especially if the property was built after September 1987. In order to do this, the property has to be income producing prior to the commencement of the renovation.
Property Tip 2
Depreciation Schedule – Once you’ve got your hands dirty and completed that renovation – get a depreciation schedule prepared on the new work that has just been completed. The depreciation process starts all over again!
Now, off you go with a spring in your step , knowing that your renovation work didn’t cost all that much since you have tax deductions to expect by the end of the year.
Work out how much you save using our free property depreciation calculator or make it happen and get an obligation free quote for a depreciation schedule now.