The best way to depreciate rental property improvements
Knowing how to correctly depreciate your rental property improvements is vital for maximising your tax deductions.
But also in keeping the ATO off your back.
Incorrect deductions are quickly identified by the ATO’s supercomputer and red flagged for further investigation.
The best, and by far easiest way to ensure you both maximise your tax refunds and stay safe of the ATO is to hire a qualified quantity surveyor to prepare your tax depreciation schedule.
Maximise deductions by knowing the difference between improvement and repair
Property improvements and property repairs are very similar, yet the ATO has very different treatment for them in your tax deductions.
While repairs can almost always be claimed at 100% write-off in the financial year the expense occurred, improvements are claimed over a much longer time frame.
For example:
I was recently inspecting a residence on the Sunshine Coast where the landlord had removed an old window mounted air conditioner replacing it with a wall mounted split system.
He wanted to claim it as 100% write-off as repairs and maintenance as the tenants broke it.
In the eyes of the ATO, he cannot do that.
That’s because he upgraded from a basic window mounted air con unit to a split system.
This meant that the new system could be depreciated at 20% pa in the Diminishing Value schedule.
It also means whatever value was left in the old air con can be claimed as an instant write-off as a scrapped asset.
Had he replaced the old air conditioner with another brand new window mounted system, the new system could have also been written off instantly.
A similar scenario plays out for Capital Works items in the depreciation report.
For example:
A house in Pimpama on the Gold Coast I recently inspected, had the guttering replaced by the owner.
If he replaced only sections of the guttering, it would have qualified as repairs and maintenance.
Claimable at 100% write-off.
Unfortunately, he replaced all of it.
This meant he could only claim the guttering costs at 2.5% pa spread out over the next 40-years.
It’s vitally important to claim your improvements and repairs in accordance with ATO guidelines- else you could end up getting probed by the taxman. And no one wants that.
Claiming deductions for improvement made after a tax depreciation schedule has been prepared?
If you carry out improvements to your investment property after your tax depreciation schedule has been prepared – all you need do is have your quantity surveyors update the report for you.
This is easily done and most QS’s, like us, will update your report for no charge when it’s minor works.
Major renovations may require an entirely new schedule being produced. This would generally require the surveyor to re-inspect your property and prepare a new report. In cases like this, you’ll probably have to invest in a new report at full cost.
What is property depreciation?
In Australia, property depreciation refers to the gradual decrease in the value of a property over time due to wear and tear, aging, and obsolescence. The Australian Taxation Office (ATO) allows property owners to claim tax deductions for this decline in value as a result of depreciation.
There are two types of depreciation that can be claimed:
- 1. Building or structural depreciation (division 43): This refers to the depreciation of the physical structure of the property, including the walls, roof, floors, doors, and windows.
- 2. Plant and equipment depreciation (division 40): This refers to the depreciation of removable assets within the property, such as appliances, carpets, blinds, air conditioning units, and hot water systems.
To claim depreciation, property owners need a depreciation schedule prepared by a qualified quantity surveyor or a registered tax agent. The schedule outlines the depreciable items and their respective depreciation rates. It helps determine the amount of depreciation that can be claimed each year.
Property owners can claim depreciation as a tax deduction in their annual income tax return. The depreciation deductions can be claimed over the effective life of the property and its assets, as determined by the ATO. The claimable amount is calculated based on the cost of the asset and its effective life.
It’s important to note that only properties built after 15th September 1987 are eligible for claiming building depreciation. However, plant and equipment depreciation can generally be claimed for both new and older properties, subject to certain conditions and dates.
To ensure compliance with the ATO guidelines and regulations, it is recommended to consult with a qualified tax professional or a quantity surveyor who specialises in property depreciation. They can provide accurate advice tailored to your specific circumstances.
What deductions can you claim?
You can claim deductions for any qualifying assets in and on your investment property.
Typically, this is broken down into two main categories:
- Capital Works (division 43)
- Plant and Equipment (division 40)
Capital Works
For residential and commercial property the build date must be newer than September 1987 to claim any deductions for the original construction costs.
However, older properties with renovations newer than that date can claim deductions for the renovations costs. Regardless of who was the owner of the property at the time the work was carried out.
For residences and commercial properties newer than September 1987, you can claim both the original construction costs and any renovations as tax deductions.
Typically, all Capital Works are claimed at 2.5% pa (of the original construction cost).
Claim depreciation to help your investment portfolio
Claiming depreciation on your investment property will give you the best opportunity to increase your cash flow. That’s because your tax deductions entitlements can come back to you in the form of tax refunds. Meaning more money in your bank account at the end of each financial year.
Better cash flow can lead to stronger borrowing capacity and the opportunity to buy even more investment properties.
What is involved in completing a tax depreciation schedule?
Completing a tax depreciation schedule is quite straightforward and only required once.
All you need do is contact your preferred quantity surveyors and have them assess your property.
This is when the QS inspects your rental property to calculate the value of all claimable tax deductible items.
Once inspected, your quantity surveyor will prepare the depreciation schedule and send a copy to you and your accountant.
Your accountant will then access the report every year when doing your tax returns.
It’s as simple as that.
Depreciation rates for used assets
Used assets may no longer be deductible in your investment property – unless you meet the ATO’s criteria.
Depreciation rates for low value assets
Low value assets depreciate at various rates due to low value assets falling inot two categories;
- Items Less than $300
- Items Less than $1,000 (but greater than $300)
Items Less than $300
Any item equal to or under $300 is generally claimable at 100% instant asset write-off.<br ?–>Note: items that are the same or significantly similar (like ceiling fans) that have an individual value less than $300 are grouped together, with the total value being the deductible rate.
What that looks like:
Say you have 4 identical ceiling fans costing $200 each. As the items are identical, you cannot claim each fan at 100% write-off. Instead, you have to pool them together and claim the $800 at 37.5% pa.
Items Less than $1,000
Items less than $1,000 are claimable at 18.75% pa in the first year of use and 37.5% pa each year thereafter.
Note: Items that are a set – such as table and chairs setting – are considered one item. So if the value is greater than $1,000 the set must be claimed in the Diminishing Value method rather than the Low Value Pool.
Do renovations affect rental property depreciation rates?
Yes, renovations do affect rental property depreciation rates.
The more extensive the renovations, the larger the tax deductions will be.
For example:
A 1992 house may have a claimable capital allowance of $50,000. With a $50,000 renovation the claimable deductions double. With a $100,000 renovation, the deductions triple. And so on.
Plus, if the renovations were carried out by a previous owner, you can still claim all the remaining deductions.
How to look up depreciation rates for rental properties
You can find the ATO approved depreciation rates for thousands of items that may be found in or on a rental property. From time to time, the ATO updates the rates of depreciation and will update their website accordingly.
Here’s a link to the ATO page where all depreciation rates can be found…
Can you just use Capital Works Depreciation rates?
Definitely. In fact, many investment properties only claim capital works deductions. That’s because their plant and equipment assets may not qualify for deductions.
Sometimes clients will have their depreciation calculations assessed by their accountant. To do this, they can only apply the most limited yearly deductions. That being the Capital Works depreciation rate of 2.5%pa. But only if the plant and equipment items are eligible for deductions in the first place.
This is not ‘best practice’ when it comes to tax depreciation and ATO compliance and we always recommend your report be carried out by an ATO compliant Quantity Surveyor.
What assets qualify for capital works deduction?
For an asset to qualify for capital works deduction we must first determine if it is considered part of the main building or part of the outbuildings and landscaping.
That’s because the two categories have different cut-off dates for claiming deductions.
Main building construction and improvements must be newer than 17 September 1987 to qualify for the 2.5% per annum capital works deductions.
This includes items like;
- Painting
- Kitchens
- Bathrooms
- Extensions
- Decks and verandahs
- Tiling
- Roof restorations – and so on
External construction works;
- Driveways
- Swimming pools
- Outbuildings
- Retaining walls
- Fencing – and so on
Must all be newer than 26 February 1992 to qualify.
Capital Works assets that don’t qualify
Non qualifying capital works are few and far between- but they do exist.
Here’s some of them;
- Previous paint jobs (you can only claim deductions for the most recent paint job. Not the one 15-layers down)
- Plants and Trees (ATO say’s because they grow they appreciate in value not depreciate)
- construction works and improvements done prior to the above mentioned dates
- Plant and Equipment that appears to be fixed in place (like carpet and light shades)
There are a few more items that rarely pop up in urban areas – like land clearing and leveling that does not have anything to do with the site preparation for a new construction build.
If you have any questions, simply ask me and I’ll give you the answer.
What to do next
If you have an investment property there are undoubtedly tax deductions available to you. All you need do is speak to your preferred quantity surveyor or a good accountant for personalised advice.
To do this, simply get in touch with us and I’ll personally look over your property via my computer and give you an eyeball estimate of deductions.
In the meantime, you may find value in reading my other articles or checking out the real world results my clients have been getting with their tax depreciation schedules.
Another good resource for you is my tax depreciation HQ page where you’ll find even more information regarding how to save tax on your investment property.
This article was written by William Callaghan A.A.I.Q.S.
2nd generation Quantity Surveyor and founder of WRC Quantity Surveying
