Step by Step Guide on How to Calculate Depreciation on a House for Taxes.
Before getting scared off by the following explanation of calculating depreciation, you need to know that tax depreciation quantity surveyors can prepare a custom 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 tax return, you can easily include the quantity surveyor’s report figures 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. They will produce a one-off report you can use year after year, and you can also claim the depreciable cost of the asset of that report as a tax deduction.
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 method of 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.
Plant and equipment refer to items within the building such as ovens, dishwashers, carpet and blinds.
Each of these two categories incurs claims. The building allowance is calculated at between 2.5 per cent and 4 per cent per year of original construction costs (depending on the date of construction).
Plant and equipment have different methods of calculating how each item can be claimed at different percentages over their effective life.
Step 1 – Input the correct data for your investment property
I’ve used the Washington Brown investment 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 tax depreciation calculator, you must press calculate, and the calculator will show the results.
To claim the actual annual depreciation assets on your investment property, you will need to get a depreciation schedule quote to determine the exact figures. This approach will be acceptable to the Australian Taxation Office as they will deny an estimate.
How to Calculate Depreciation Rate
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 essential and can be an area of confusion for many property investors.
Let’s 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 to calculate depreciation on building:
As the term suggests, the building allowance refers to 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 based on the building’s construction cost (not the purchase price). You have to be aware of several essential things when claiming building allowances, particularly the age of the building or the year of construction.
Remember 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 per cent depreciation rate and are depreciated on a straight-line basis (i.e. you claim the same amount every year) over a number of years, 25 to be exact.
Residential properties constructed after September 1987 are depreciated at 2.5 per cent on a straight-line basis over 40 years.
The building allowance rate is a deduction the government can change to stimulate building activity in targeted areas. The rate was increased for two years between 1985 and 1987 to encourage growth. The construction of new, serviced apartments, short-term traveller accommodation, and certain manufacturing buildings currently qualify for the 4 per cent building allowance.
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 calculate yearly depreciation?
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 due to the Budget 2017 depreciation changes. 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 rental property.
You have just paid hundreds of thousands of dollars for a property. Do you 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 ten 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 estimate the construction cost accurately.
At Washington Brown, we know how to calculate depreciation on investment properties. That’s what we do daily, whether 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 that Washington Brown will individually analyse your property and provide a depreciation plan.