The changing nature of depreciation
Accountants should be well aware of the recent changes to depreciation in order to maximise tax deductions for clients considering the purchase of a property.
Depreciation claims still strong despite changes
During the 2015-16 financial year, just under 3 million property investors claimed deductions relating to their rental property.
Of these investors, 1,381,138 claimed an average capital works deduction of $2,326. This was an increase of 2.71 per cent when compared with the average capital works deductions claimed during the 2014-15 financial year.
Just over 2 million property investors claimed an average of $1,324 in plant and equipment depreciation deductions during the 2015-16 financial year, according to the ATO statistics. This was a 3.92 per cent increase when compared with the average plant and equipment deduction claimed during 2014-15.
According to the ATO statistics, investors claimed a total average depreciation deduction of $3,650 during the 2015-16 financial year. However, BMT Tax Depreciation found our clients had an average total depreciation deduction of $9,099 during the same financial year.
Following the changes made to depreciation legislation regarding plant and equipment found in second-hand properties in November 2017, it will be interesting to observe the ATO statistics as they are released for recent financial years.
During 2016-17, BMT saw a slight decrease in the total average depreciation claim to $8,972. However, this decrease is to an extent due to a number of older properties nearing the end of their 40-year effective life.
Despite the changes that have occurred to depreciation legislation, we are still finding our clients an average of $8,893 in deductions during the 2017-18 financial year for all residential properties.
Furthermore, those properties directly affected by the changes in depreciation legislation, i.e. second-hand properties where contracts were exchanged after 7:30pm on 9 May 2017, still had an average claim of $5,033 in the 2017-18 financial year.
Changed legislation benefits renovators
Renovating or ‘property flipping’ has become a huge trend in Australia, especially on the eastern seaboard where almost 7 per cent of transactions in Sydney, Melbourne and Brisbane were sold shortly after purchase following a renovation, according to CoreLogic.
CoreLogic’s data also demonstrates that 90 per cent of properties flipped during 2017 were sold for a profit.
‘Property flipping’ occurs when an investor buys, renovates and resells a property within a relatively short space of time, with the intention of making a profit.
Legislation passed through the Senate on 15 November 2017 has changed the way depreciation for pre-existing plant and equipment found in second-hand properties will be treated.
Plant and equipment depreciation covers all removable and mechanical assets, which generally depreciate faster than the building.
The legislation states that investors who purchase second-hand residential properties after 7:30pm on 9 May 2017 cannot claim depreciation on pre-existing plant and equipment, unless the property is deemed to have been substantially renovated or is brand new.
Below are some examples of structural and non-structural works that, in combination, could be considered substantial when property flipping:
- Structural: altering, removing or replacing foundations, floors, supporting walls or part thereof (interior or exterior); lifting or modifying roofs; replacing existing windows or doors where brickwork is altered (single to double door);
Non-structural: replacing electrical wiring or plumbing; replacing, removing or altering non-supporting walls.
So, if a property is considered to be substantially renovated before it is sold, then the plant and equipment depreciation can be claimed on all the removable and mechanical assets by the new owner.
Capital works deductions on the structure of a building, including any fixed and irremovable assets, were not affected by the new legislation and generally make up 85 to 90 per cent of the total claimable amount. Current investors can continue to claim these deductions for both existing and new additions, regardless of when the work took place.
To demonstrate, we looked at an example of a second-hand property built in 1973 that an investor recently purchased.
The property had recently undergone a renovation. Due to the extent of the renovation, BMT could assess the property as substantially renovated, allowing the new owner to claim depreciation for all the plant and equipment, and new capital works.
In addition, during their inspection, BMT identified that a small extension had taken place in 1998. Because capital works deductions are unaffected by the legislation change, the current owners were able to claim it for this renovation, even though it was completed 20 years ago by previous owners.
Assumptions and disclaimers
BMT identified $8,250 in both capital works and depreciation deductions for the new owner of this property.
Investors who renovate a rental property they own must note that they are likely removing structures or assets that have a remaining un-deducted value. This can be claimed as a deduction in full when the asset is removed.
Bradley Beer, chief executive, BMT Tax Depreciation