Depreciation schedules for rental properties, why are they so important?
If you own a rental property (whether acquired new or second hand from a previous owner), you need to know how to maximise the return on your investment. If you’re like most property owners, you don’t want to pay more than you have to in taxes. After all, that’s money that could have been put to better use in your business or home. The good news is that as both a property investor and an Australian taxpayer you are entitled to claim significant depreciation tax write-offs on your property investment asset.
Therefore, all property investors will need a depreciation schedule for rental property owned.
How to take advantage?
The means to achieve this is via using a tax depreciation schedule (tax depreciation report)
With this rental property depreciation schedule, the landlord has the ability to reduce their taxable/assessable income by an average of $6,000 – $12,000 (more for higher specification homes) each financial year over the effective life.
The tax depreciation schedule is an important tool for the owner of a rental property as it both verifies and certifies the entitled tax depreciation claims that they can include in their yearly income-tax return as capital/building depreciation allowance and deductions (i.e. tax write-off).
Furthermore, these tax write-offs will most likely be the biggest single deductions, having the most weight in resulting in a significant income tax reduction or better yet a cash tax return from the Australian Tax Office (ATO).
The schedule identifies capital works deductions and capital works allowances (via a property inspection) as well as the assets effective life (how many years that the asset can be claimed against), residual value (the value left in the asset to write-off).
The depreciation schedule includes the building component (capital works and improvements) as well as the depreciable assets (e.g. carpets, blinds etc.), fixed assets and their residual values.
What is the depreciation rate for a building (residential investment property)?
The depreciation rate for a building is a very valuable concept for property investors because it allows investors to depreciate the investment property in the same way as the businesses depreciate their assets.
To put it simply, the depreciation rate is the decrease in the value of your property over a certain period of time. It is calculated by dividing the total construction cost (estimated by a qualified quantity surveyor in the absence of actual costs) of your residential property by a set percentage rate over the effective life of the building
On a residential rental property, this rate of deduction is 2.5% of the construction cost year-on-year, annual allowable tax deductions that are made by landlords who own investment properties (new and older property) in Australia.
Common questions in respect of depreciation schedules for rental properties:
How do I calculate depreciation on rental property?
In order to calculate depreciation on rental property, firstly, individuals cannot do this themselves and the ATO stipulates that accountants aren’t suitable qualified to do this either…accountants can guide you, but they are not qualified to provide this specialist service.
There are several options for calculating depreciation, the most common is the prime cost method (straight-line) depreciation, where an asset is depreciated by a fixed amount over its useful life. However, the diminishing value offers more depreciation sooner as the depreciation rates are higher.
You will require the services of a quantity surveyor, in or to provide a property tax depreciation schedule (and to categories the allowances and deductions into the format that is both valid in the eyes of the Australian Tax Office (ATO), interpreted by accountants but ultimately significantly improve the rate of tax write-offs to benefit the tax payer.
What is the best depreciation method for a rental property?
The best depreciation method for a rental property depends on the tax-payers financial position and the skill of a quantity surveyor that prepares the depreciation schedule.
In general, there are many different methods for calculating depreciation for a rental property in Australia, some of which are better than others. the diminishing value method is the most popular, as more claims/tax write-off can be claimed for sooner. A good quantity surveyor can further improve the allocation and accelerate depreciation methods by such methods as ‘low-value pool’ etc. Whereas, a common depreciation method (applied to the capital works deductions) is the straight-line depreciation method whereby the same amount of depreciation is allocated to each year of the asset’s useful life. A sum of the years’ digits depreciation method is depreciation that is allocated each year based on the sum of the digits for that year and the useful life of the asset.
In simple terms, it is generally better to claim what you can, as soon as you can.
What happens if I don’t depreciate my rental property?
If a rental property owner does not depreciate the rental property, in simple terms, they will forfeit all allowable depreciation tax write-off benefits. On average this amount can equate to around $7,000 every financial year. If you plan to never sell, this is foolish and a missed opportunity.
The only reason why you may not want to depreciate your property is when you plan to hold for a very short time and sell. This way there will be no depreciation implications on Capital Gains tax as the cost basis would not require adjusting. (Capital Gain, the increase in value of the property).
Is it mandatory to depreciate rental property?
It is not mandatory to depreciate rental property, but the Australian Tax Office (ATO), as part of the Commonwealth Government, has been gathering tax and revenue for years from Australian taxpayers, as a rental property owner (investor) you are entitled to claim significant property depreciation (as a tax write-off) on an annual tax return or tax declaration. This is due to the fact that your rental property is a depreciating asset. Therefore, you are entitled to a depreciation claim for the deduction of the decline in value of the property each year in your tax return in a very cost-effective means (via tax depreciation).
A depreciation estimate (perhaps via a tax depreciation calculator) can identify the obvious benefits.
Do I need to wait for tax time to organise a property depreciation schedule?
One does not have to wait for tax time to organise a property depreciation.
Prudent property investors will not want to forget and potentially forfeit the ability to take advantage and will organise a report without delay. Any delay has other consequences i.e. on third parties (involved in making it possible for the rental property owner to claim) e.g. accountants and quantity surveyors. For instance, to short a turn-around from a late request), may place too much pressure to have the report organised and completed in a timely fashion.
Therefore, having a tax depreciation schedule organised and completed well before tax time is always the best option, enabling sufficient time to include the report in the associated income tax returns. Most quantity surveyors will also coordinate with client’s accountants anyway so the client does not have to worry either.
Can you write off renovations on a rental property?
Renovating your property investment to increase the chances of it returning better tax write-offs, but ultimately improve the income is a wise decision, if not over capitalised.
However, it can be a difficult decision to make when you are not sure if you can write off the improvements (in the first instance). Every investment has two elements, the initial outlay and the ongoing income stream. When you renovate a property to increase the rental income, you are investing in the property and adding ‘construction expenditure’. This means the property investor can claim the improvements as a tax depreciation deduction.
Plan to renovate an investment property or buy an existing, ‘substantially renovated’ property. There are many benefits.
Can rental property depreciation offset ordinary/taxable income?
Via tax depreciation i.e. claiming the depreciation of the rental property, offsets the income earned from it and reducing the taxpayers overall tax liability.
Secondly, there are also tax deductions of ‘expenses’ on rental properties as there are also many costs that are unique to rental properties of which incur costs (that are claimable). These costs include repairs, insurance, and property management fees. These costs are typically tax-deductible for landlords. This method claims the rental property expenses (costs) as a tax-deductible operating expense. Not sure which tax deduction you can claim as an expense? Speak to a registered tax agent or an accountant.
Both methods will improve the property cash flow.
For real estate depreciation purposes (irrespective of whether in a SMSF), if you require a property depreciation report to tax advantage of the tax benefits, improve your investment property cash flow and cash returns get in contact with BWK Group.
Difference between Capital works deductions and allowances:
The differences between a ‘capital works deduction and capital allowance’ is as follows…
Capital works deduction (Division 43): construction expenditure (e.g. buildings, extensions, alterations and structural improvements).
Capital works allowance/Building allowance (Division 40): depreciable asset/plant and equipment (e.g. carpets, blinds, kitchen appliances etc.).