Claiming Depreciation On your Investment Property
When you build a new investment property, it’s important to understand how depreciation works. There are plenty of explanations out there – however, many contain financial mumbo jumbo, so you end up more confused than when you started!
With over 40 years’ experience building homes, Metricon has learnt a thing or two about the benefits of depreciation. To help investors understand the key principles of depreciation, Metricon recently supplied this ‘jargon-free’ explanation.
We hope it helps give Investors an appreciation for depreciation!
What is depreciation
It’s fair to say that depreciation is a complex topic. There would be plenty of first-time – or even experienced – investors out there who don’t fully understand how to take advantage of the depreciation deductions they’re entitled to.
So, what is the definition of depreciation? Like other investments, it’s the general wear and tear that your asset suffers over time. The Australian Tax Office (ATO) says that this decreases the value of an asset over time so that you can claim a certain amount as a tax deduction each year.
How you can claim depreciation
As a property investor, you can claim two types of depreciation – capital works deductions and plant and equipment assets.
Capital works deductions
Capital works deductions relate to the structure of the home, as well as assets thought to be permanent such as doors, cupboards, walls and windows. One of the cleanest ways to benefit from capital works deductions on an investment property is by building a new home.
When you build a new home, you can claim depreciation on the cost of the construction at 2.5% over 40 years. The time frame is set at 40 years because that’s how long the Australian Taxation Office (ATO) has determined a house will last before it needs to be replaced.
Plant and equipment assets
Plant and equipment assets are the fixtures and fittings of a home that are not designed to last for 40 years like the home. They can include things like the stove, the carpet, the hot water system, the blinds etc. If you can easily remove and replace it, it’s likely that it falls under plant and equipment assets.
The ATO again determines the life of each asset. The life of an asset is known as the “effective life”, although some call it the useful life. The useful life is the number of years an asset is likely to remain in service.
Claiming depreciation on plant and equipment assets only applies when you build a new home for investment. In 2017, the government passed legislation changes so that investors buying a second-hand property could not claim plant and equipment deductions if they’d been used.
How to make claims
Luckily, there are people who are skilled at determining what counts as capital works or the useful life of assets. A quantity surveyor who will do all of this work for you for a fee.
Not only will they provide a report covering the claimable depreciation, but most quantity surveyors will go one step further and send it directly to your accountant, who will run the claims for you. It couldn’t get any easier!.
Quantity surveyors know everything about fixed assets, obsolescence, depreciation expenses, depreciation schedules and balance sheets, taking these fiddly calculations off your to do list.
Prime cost method vs diminishing value method
Of course, to add another level of complexity to plant and equipment assets depreciation, the ATO allows for two depreciation methods. The two different methods are the prime cost method and the diminishing value method.
Prime cost method
Also referred to as the “straight-line method”, choosing the prime cost method will give you the same amount of depreciation with each claim. The straight-line depreciation method means that, if the useful life of an asset is ten years, and your first payment is $100, the next nine payments will also be $100.
Diminishing value method
The diminishing value method will allow you to claim higher amounts in the first few years of an asset’s life, and smaller amounts towards the end of its useful life. The first year will have the highest return whereas the last year will be much lower. This sum has to do with the original cost of the asset at the beginning of its life.
When it comes time to choose a depreciation method, you should rely on your accountant to advise which method will work best for your situation.
Understanding depreciation is essential for any budding property investor, as it can put money back into your pockets at tax time. While you must have an idea of how it works and what you can claim, you should still rely on the professionals – quantity surveyors and your accountant can team up to get the best results for you.