Appreciating (and understanding) depreciation
You’ve probably done a lot of math while managing your investment property. You’ve calculated property management fees, maintenance and what the weekly rent should be. You probably know your advertising fees and what any incidentals like gardeners and regular maintenance cost you. But have you ever considered the money that your property can save you? Or how much of the money you spend that you can claim back? To put it another way, do you know how to claim depreciation on your property? Are you even really sure what it is?
Please note: this article discusses depreciation schedules for investment properties. Some items can only claimed on your tax return if they are connected to a rental or investment property, not your primary home.
What is depreciation?
Do you know how some things are ‘worth’ less and less each year, like cars and phones? Depreciation is a way of acknowledging that reduction in value. It’s the opposite of when things ‘appreciate’ in value, like collectibles do. Australian owners of income-producing property can claim this depreciation as a deduction against their tax when filing their personal tax return.
Depreciation reduces your tax liability in a way that reflects the reduced (and reducing) value of your assets, namely your investment property (or properties).
There are two types of depreciation: capital works, and plant and equipment.
Capital works refers to wear and tear to the property, as well as major works such as renovations. Think of this as work done to the skeleton of your property.
Plants and equipment refer to wear and tear and replacement of fixtures and fittings, like carpet and appliances (think dishwashers and hot water services). If it’s easily replaceable, it’s probably considered plants and equipment. They’re more like the clothing of your property.
Now that we’ve discussed the kinds of things that can be claimed, how much can be claimed?
Tax depreciation schedules
Depreciation is calculated as a percentage reduction in the value of an asset each year. You might think that this means there’s a neat annual percentage for your capital works and your plants and equipment costs, but unfortunately it’s not that simple. Not all items depreciate at the same rate. This can be a bit of a pain to keep an eye on, but if you want to maximise the depreciation of your property, it’s important to do your homework. Another thing to remember is that, regardless of whether or not you can be bothered keeping track of how quickly these things wear out, they will wear out anyway. Carpet needs replacing, ovens eventually stop working, curtains get damaged — over time you will need to replace these, so keeping an eye on your depreciation schedule will let you check not only when something’s tax value to you is zero (or very low), but also when it’s most timely to replace them. Don’t forget, once something has depreciated to nothing, you can’t claim it as a deduction anymore.
To understand how much your property depreciates each year, you will need to contact a quantity surveyor to produce a tax depreciation schedule for you. This schedule should include both capital works and plant and equipment. This will give you an idea of how much you can claim against your tax each year. Many investors with huge portfolios even factor depreciation in their property purchasing decisions, so the sooner you get a handle on it, the sooner you can make your money work a little harder for you.
If your properties are rented out with minor appliances supplied, don’t stress. You won’t have to keep track of the kettle for 10 years. Items that cost under $200 are claimable in full on your next tax return.
Do all properties depreciate the same?
All properties depreciate, but the rules aren’t always the same. If a property was built before September 1987, unfortunately capital works allowance deductions are no longer available on the original structure and any fixed assets. However, renovation works undertaken since then are still eligible. This is obviously less of an issue if you’re dealing with newer properties, but it’s worth keeping in mind.
Something else to keep in mind is that for properties purchased after 9 May 2017, the new owners cannot claim depreciation on plants and property that were already installed at the time of purchase.
Something else to note as well: If you’ve purchased a property built after 1985 that has been renovated, but not while you’ve owned it, your accountant cannot estimate the value or cost of that construction work. Neither can anyone else (including property managers, builders or your mate up the road) — estimations for such works must be done by an appropriately credentialed quantity surveyor. If you don’t have receipts for work that was done prior to you purchasing a property, you MUST have a quantity surveyor estimate the value of that work for tax purposes. It might all seem a little fiddly, but tax matters often are, and that’s why people leave money on the table. At the end of the day, no one is going to chase you up to make sure that you’re getting every last dollar back out of your property. If you’re happy to leave money on the table, ignore depreciation. But if you’re keen on maximising your returns, particularly if you have expensive property or an extensive portfolio, it’s worth finding a surveyor to help walk you through creating a tax depreciation schedule. Once you get an idea of how much it’ll save you in a year, and you learn the basics, it’ll be easier for you to record everything that you need to make tax time each year a breeze. We’ve said it before, but it bears repeating: if you do the work upfront, you’ll save yourself time, stress and money in the long-term.