Step by Step Guide on how to calculate depreciation on your investment property.
Before getting scared off by the following explanation, you need to know that a quantity surveyor can inspect your property and pre- pare a depreciation schedule for you. All you’ll need to do is hand it over to your accountant at tax time. And that’s all you need to know if you wish. If you lodge your own tax return, you can easily include the figure from the quantity surveyor’s report yourself.
You don’t need to worry about complicated calculations. In practice, it’s as easy as a phone call to a quantity surveyor to ensure you get all your allowable depreciation deductions. He or she will produce a one-off report you can use year after year, and you can claim the cost of that report as a tax deduction as well.
Many investors, however, will want to understand the process for themselves. So, now for the nitty-gritty. Here is an explanation of the laws behind depreciation.
To give you some background, there are two parts of the Income Tax Assessment Act 1997 we are dealing with here:
The capital works allowance (more commonly referred to as the building allowance) refers to the construction costs of the building itself, such as concrete and brickwork. (In Chapter 4 we look at capital works in more detail and give you a detailed list of inclusions.)
Plant and equipment refer to items within the building such as ovens, dishwashers, carpets, and blinds, etc.
Each of these two categories incurs claims. The building allowance is calculated at between 2.5 percent and 4 percent per year of original construction costs (depending on the date of construction).
Plant and equipment have a number of categories in which items are claimed at different percentages over their effective life.
Step 1 – Input the correct data for your investment property
I’ve used the Washington Brown property depreciation calculator to demonstrate the following example of how much you can claim on a standard, new, high-rise, two-bedroom unit in Sydney, bought for $750,000.
Step 2 – Getting the calculated results.
Once you have inputted the correct data on the Washington Brown property depreciation calculator all you need to do is press calcuate and the results will be shown.
In order to actual depreciation on your investment property, you will need to get a depreciation schedule quote – so the exact figures can be determined. Only this approach will be acceptable to the Australian Taxation Office as an estimate will be denied.
What are the two components need to calculate the correct depreciation?
As I mentioned earlier, there are two types of depreciation, namely:
- building allowance (also known as capital works allowance); and
- plant and equipment.
As I said, most people only know half the story and think that depreciation only applies to the building – the actual structure of a house, a unit, or any property investment. But the other half of the equation – plant and equipment – is equally important and can be an area of confusion for many property investors.
Let’s have a look at each of these two areas in more detail to make sure that you understand them and can maximise depreciation benefits from your investments.
The building allowance – how is it used to calculate depreciation your investment property?
As the term suggests, the building allowance refers to the bricks and mortar – the actual structure – of the building. These are also referred to as ‘capital costs’.
Here’s a list of the most common type of items covered in the building allowance:
Brickwork • Concrete
Tiling • Roofing
Gyprock • Kitchen cupboards
Carpentry • Electrical wiring
Plumbing • Painting.
Deductions in this area are calculated on the construction cost (not the purchase price) of the building. There are several important things you have to be aware of when it comes to claiming building allowances, particularly the age of the building or the year of construction. Keep in mind that residential properties built before July 1985 are not eligible for this deduction. Residential properties built between 18 July 1985 and 15 September 1987 have a 4 percent depreciation rate and are depreciated on a straight-line basis (i.e. you claim the same amount every year) for 25 years.
Residential properties constructed after September 1987 are depreciated at 2.5 percent on a straight-line basis over 40 years (more about the straight-line method of calculating your allowance later in the chapter).
The rate of the building allowance is a deduction the government can change to stimulate building activity in targeted areas. As you can see in Figure 4.1, the rate was increased for two years between 1985 and 1987 to encourage growth. The construction of new, serviced apartments, short-term traveler accommodation, and certain manufacturing buildings currently qualify for the 4 percent building allowance too.
For example, if you purchased a newly-built house on 1 January 2000 for $300,000, and its construction cost was $200,000, you would be able to claim $5,000 (i.e. $200,000 × 2.5 per-cent) per year of building allowance deductions until 1 January 2040.
Plant and Equipment – How is it used to calculate depreciation on your investment property?
Plant and equipment is the other part of the equation that confuses people. Many clients are surprised when we tell them that they can claim depreciation on a raft of items in their investment property – items that they did not directly pay for.
But this is also the section that has changed the most with the new legislation. In order to claim these items:
- In a second-hand residential property you bought after 9 May 2017, they need to be brand new;
- If you bought the property prior to 9 May 2017 (before the budget changes came into effect), they could be previously used as stated for residential properties; or
- If they are in a brand-new property, you can claim them as before.
Here is a list of the top 10 most common items eligible to be claimed under the plant and equipment category:
- Clothes dryers
- Washing machines.
Remember, if you’ve acquired the property after 9 May 2017 – and it is not a brand-new property – you will no longer be able to claim the depreciation of the previously used assets. Instead, it will form part of your cost base for capital gains purposes. However, you’ll still be able to claim these items if the property is brand new or you acquire them directly yourself. Again, this only applies to residential property and there’s been no change to commercial, industrial, retail, and other non-residential type properties.
Finally, engage a Quantity Surveying firm to calculate the depreciation on your investment property.
You have just paid hundreds of thousands of dollars for a property. Do you really want to save a couple of hundred tax-deductible dollars on the only tax break available to you that can be open to interpretation and skill?
The laws have changed frequently over the years and each building is unique, so it pays to get expert advice.
I suggest you engage a firm that has been around for at least 10 years. They will have the necessary experience to analyse your property correctly. Don’t fall into the trap of assuming that anyone involved in the project can accurately estimate the construction costs.
At Washington Brown, we are experts at estimating construction costs. That’s what we do on a daily basis, whether it is for an investor, a property developer, a property financier, or a builder.
Not every property needs a depreciation inspection now, due to the changes in the tax depreciation law for investment properties.
The good news is Washington Brown will individually analyse your property and provide a depreciation plan for your property.
Watch the video below to learn how to calculate depreciation on your property investment using the property depreciation calculator.