The Top 14 Depreciation Law Questions Arising from the Budget Changes

Well, the dust has finally settled on the new legislation regarding 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.

As you already know, in 2017, the rule book on depreciation changed massively.

The Federal Government successfully voted on new legislation to change the way depreciation works, representing the biggest move in the industry that I’ve ever seen – and I’ve been a quantity surveyor for over 25 years!

The changes were effective as at 9 May 2017 at 7.30pm, when the federal budget was handed down. As you can imagine, they have huge implications for property investors and more importantly, the property equation, which we’ll go into later.

So, how have things changed exactly?

The best way to understand it is to break the changes down into nine simple key points:

1. If you acquire a second-hand residential property from 10 May 2017, which contains ‘previously used’ depreciating assets, you will no longer be able to claim depreciation on those assets. This refers to the plant and equipment portion of a depreciation schedule, including:
• Ovens
• Dishwashers
• Lights
• Air-conditioners
• Televisions
• Carpets
• Lounge suites
• Blinds
• Common property plant and equipment items.

2. However, 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, which typically accounts for 85 per cent of the overall construction cost. The structure includes things like brickwork and concrete so there’s no change to that.

3. Acquirers of brand-new property will carry on claiming depreciation in exactly the same way as they have done so to-date – for both plant and equipment and structure. This is great news for the property industry, because a lot of developers rely on depreciation as part of their marketing strategy to attract investors. The government resisted making changes to depreciation on brand-new property because it did not want to halt construction, which would have impacted upon the supply of new property. A downturn in the construction industry would also have a knock-on effect – if tradies are out of work, they aren’t paying tax!

4. If you renovate a house while living in it, then sell the property to an investor, the assets will be deemed to have been previously used and the new owner cannot claim depreciation on the plant and equipment.

5. 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. In other words, you can still buy a second-hand property in a company name and claim depreciation on it. You can buy a second-hand property in a super fund – as long as it’s a large one – and a large trust can buy a property as long as it has 300 members
or more, and claim depreciation on that property.

6. The proposed changes only relate to residential property. Commercial, industrial, retail and other non-residential properties are not affected, so you can still buy a second-hand office or similar and continue to claim the second-hand carpet, exactly as you could before. You can’t do this for residential property, as I’ve explained above.

7. If you engage a builder to build a brand-new house, or do the work yourself and it remains an investment property, you will still be able to claim depreciation on both the structure and the plant and equipment items. This is because it’s brand new, and was brand new when you put in that oven. Therefore, you can still claim it because the costs are known.

8. If you engage a builder to renovate a property – or you do the work yourself – and it is also being used as an investment property, you will still be able to claim depreciation on it when you have finished the renovations. As above, this is because the assets you install are brand new, therefore you can still claim. But if you bought a property renovated by someone else and they lived in it for six months or a year and then sold it – you can’t claim depreciation on the oven and dishwasher, etc. in the future, because they have now been previously used. See the difference?

9. While 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, when they replace or remove an item of plant & equipment they would have been able to claim in depreciation under the previous legislation, the opening value of the asset can be claimed as a capital loss.

In my opinion, it seems like a lot of work to get the same result. The new rules have just moved depreciation from one line of the budget to another!

The good news is that the new legislation is ‘grandfathered’. That means that for everyone out there with an existing depreciation schedule, you can continue to claim exactly as you have been doing. So, if you bought a property prior to the budget – 9 May 2017 – nothing has changed. And if you have bought an investment prior to this date, and you don’t have a depreciation schedule, there’s never been a better time to get one! You might not get these allowances again.

One final point on grandfathering; 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.

Those items will be deemed to be previously used and caught in the net of the changing legislation – even though you acquired the property prior to the budget. So, these changes are kind of ‘half grandfathered’ if you ask me.

You will, however, still be able to claim the building allowance in this scenario if the property was built after 1987.

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. That is unless you live in the property as an owner occupier at any time after its completion, this would then mean the plant and equipment assets are deemed ‘previously used’.

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2. How do these new changes affect purchasers of non-residential property like offices and industrial suites?

The proposed changes only relate to residential property. Commercial, industrial, retail and other non-residential properties are not affected in the slightest.

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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.

Now would be a good time to get a quote for your depreciation schedule.

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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.
Go figure!

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5. If I buy a property in a trust or company will I get around these laws?

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.

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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.

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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.

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8. What happens if I buy a unit that’s 3 months old where the developer has already found a tenant and is selling it “as new”. Can I claim both the plant and equipment and the building allowance?

In this case, the answer is yes. The new legislation allows a developer 6 months to find a tenant and sell it as a leased investment without nullifying the depreciation claim to the incoming buyer.

This was a late change to the legislation and occurred after industry consultation between the treasury department and the property industry (including myself).

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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.

If you own an overseas investment property, start claiming the deductions, we do many reports worldwide.

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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.

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11. What happens when you sell the property that you bought after the 2017 budget?

The Budget statement words it like this: ‘Acquisitions of existing plant and equipment items will be reflected in the cost base for capital gains tax purposes for subsequent Investors.’

This video explains the changes and also outlines our new report offering:

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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:

Scenario 1:

An investor buys a brand new unit or house for $850,000.
Depreciation Budget Changes

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.

Scenario 2:

An investor buys a residential house or unit for $850,000 that was built in the year 2000.

Depreciation Budget Changes

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.

Scenario 3:

An investor buys a residential house or unit for $850,000 that was built prior to 1987 – that hasn’t been renovated.

Rental Property Depreciation Budget Changes

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.

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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.

Go figure.

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.

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14. I have been asked this many times: “Tyron, what do you think about the changes?”

I agree that the constant revaluing of plant & equipment items on very old properties made no sense and needed refinement.

However, I think the approach the Government has taken in disallowing depreciation on properties that are near new doesn’t make a lot of sense and could’ve been rolled out far more logically.

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The Budget Change And How It Affects Our Rental Property

rental 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 Depreciation Quote Schedulemoved 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):

Depreciation Calculator“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. “

 

Note worthy:

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.

Property Opportunities in Perth and Darwin

Are there opportunities to buy an investment property in Australia’s two down markets?

Having both been hit by the downturn in the resources industry, the capital cities of Perth and Darwin have seen declines in their respective property markets. Both in terms of prices and rents, with vacancy rates also creeping up at times.

According to the latest figures from CoreLogic RP Data, Perth and Darwin are the only two markets to have recorded a drop in the median dwelling price over the past year. Recording falls of 2.1% Depreciation Quote Scheduleand 3.7% respectively to sit at just over $500,000.

Total gross returns for these cities are currently the lowest in Australia by far! Sitting at 1.9% for Perth and 1.7% for Darwin. Rental yields for Darwin are still some of the highest in the country. Darwin is around 5%, while for Perth they’re a little lower, at around 4%.

The experts largely agree a recovery for Perth and Darwin isn’t on the cards anytime soon. Some see now as a good opportunity to buy into these markets. Others believe it’s better to wait until they bottom out.

But where should investors looking at taking advantage of the opportunities offered by these down markets be focusing? We asked these experts to name their top investment locations for this year.

 

Perth offers the best opportunities

With the market in a down cycle, Hotspotting.com.au founder Terry Ryder believes Perth might offer the best opportunities this year for investors.

“Most investors pile into markets when there’s a boom on, but the smart ones get into areas when they’re down, and one place to be considering now is Perth,” he says. “Investors should look to buy there if they believe Perth and WA have a future, which I do.”

Ryder adds, however, that there’s no pressure to act quickly. There’s a lot of stock for sale and not many buyers around.

Perth’s property market peaked around three years ago, he says. And it’s been going backwards for the past year or two in terms of both prices and rents. He expects it to hit the bottom sometime this year.

property opportunities in perth and darwin

His top picks for investors buying in Perth this year are the southern inner city suburbs of Victoria Park, East Victoria Park and Carlisle.

These suburbs are not only close to the CBD, at a distance of no more than six kilometres. They’re also close to the Swan River and relatively close to the Perth Airport, Koulizos says.

Ryder, meanwhile, likes the outer areas of Perth when it comes to investment potential.

“We tend to find in most cases the areas that show the best long-term growth are cheaper or middle-market areas. Not the top-end areas, and a lot of people can’t afford the top end,” he says.

Ryder adds that investors should follow the infrastructure trail, as infrastructure is a good generator of residential property growth.

In Perth, he says, there are plenty of affordable areas with good infrastructure. Including the City of Armadale, around 25 kilometres southeast of Perth; the coastal City of Rockingham, around 25 kilometres south of Perth; and the City of Swan, around 20 kilometres northeast of Perth.

The City of Swan, elaborates Ryder, is close to the airport and centred on the suburb of Midland, which is an administrative centre with lots of facilities.

Another area to consider, according to Ryder, is the local government area of Kalamunda, and specifically, the suburb of Forrestfield. He says there’s a plan for a new rail link to the airport and the CBD which will be a “game changer” for the area.

Ryder also warns there’s a potential oversupply of inner city apartments in Perth, and therefore this market should be avoided.

 

What about regional areas of Western Australia?

Property investors should avoid the regional areas of WA impacted by the downturn in the resources sector, according to Ryder. He describes towns such as Port Hedland and Karratha as “basket cases”. And says they’ve got a long way to go before they recover. Depreciation Calculator

Ryder adds that lifestyle areas such as Mandurah, Margaret River and Busselton, are the best places to consider in regional WA.

 

Where to look in Darwin

There’s no doubt Darwin is the weakest market in Australia at the moment, according to Ryder.

He says it’s really a small town and while its heavy reliance on the resources sector saw it perform well a few years ago, that same dependence has now led to its market suffering.

“It needs something new to come along and reinvigorate the economy and property market, but there’s really nothing major on the horizon to give it a boost,” he says.

So are there opportunities for investors to buy in Darwin while the market is down, just as there is in Perth? According to the experts, Perth is the safer bet.

Ryder says Perth is a more substantial city and economy and Darwin is more remote, like a large regional centre.

“I’m not sure where the recovery in Darwin will come from,” he says. “It needs one or two major projects to come along and give it a kick start.”

Koulizos agrees that there won’t be a recovery in Darwin anytime soon. But for those looking to buy his pick is the northern suburb of Rapid Creek, close to both the CBD and the water.

 

Stay tuned for the next instalment in our ‘where to buy’ series

Next month we look at where investors in some of the often-overlooked capitals, including Adelaide, Canberra and Tasmania, should be looking to buy.