It can be a great tax break but turn to the experts to get your claim right, Janet de Silva writes.
Who doesn't love a tax break? Property investors especially love them, because such breaks can enable them to invest in a property they could otherwise not afford.
Depreciation claims and capital works deductions in particular can slash the holding cost of an average rental property by as much as $100 a week, if not more.
Yet a surprising number of the nation's 1.5 million property investors - some estimates are as many as 80 per cent of investors - either don't claim depreciation and capital works deductions or underestimate their claims. At the other end of the spectrum there are some investors who overestimate these deductions and risk catching the eye of the Tax Office.
HOW DEPRECIATION WORKS
There are two types of rental property costs to depreciate. The first concerns depreciation for wear and tear of fixtures and fittings that were included in the property purchase or that you subsequently purchased for your property.
The second relates to capital works deductions (also known as building allowance), which are applied to the cost of the construction of the building (if built after 1985) and spread over a period of 25 to 40 years.
Residential buildings constructed between 1985 and 1987 can be depreciated at a rate of 4 per cent a year, while those built after 1987 can be depreciated at the rate of 2.5 per cent a year.
As a general rule, depreciation claims on fixtures and fittings are of most value in the first five years of property ownership, while capital works deductions remain constant for the 40-year period.
Older properties can qualify for depreciation or capital works deductions if they have been renovated or extended since 1985.
HOW MUCH ARE THEY WORTH?
One of the better things about making depreciation claims is that they are non-cash deductions. That is, you don't have to outlay any cash to get the deduction. The Tax Office allows you to make the deductions because it acknowledges that the fixtures and fittings of the property, and the building itself, will be worth virtually nothing after a certain period of time.
Brad Beer, a director of the quantity surveyor firm BMT & Associates, says depreciation claims and capital work deductions can be worth up to $10,000 each year for the first five years on an average $400,000 two-bedroom apartment (see table below). For an investor paying tax at the top marginal rate, this equates to a reimbursement of about $86 a week. For those on lower marginal tax rates, however, the amount is less.
WHAT ITEMS TO INCLUDE
The list of fixtures and fittings for which depreciation can be claimed reads like a builder's shopping list. Aside from the obvious items such as dishwashers, stoves, air-conditioners, carpets and blinds, there are many items that could be easily overlooked.
These include range hoods, security systems, floating timber floors and spa bath pumps.
If your investment property is part of an apartment complex, depreciation claims also apply (proportionally) to fixtures and fittings in common areas such as stairwell carpets, security and fire systems, even gym equipment.
While many investors leave the task of estimating their depreciation claims to their accountant, or even attempt the exercise themselves, there is value in seeking the help of a quantity surveyor who specialises in this area.
Brad Beer says most investors who employ the services of a quantity surveyor to complete a tax depreciation and capital allowance schedule will profit from the exercise. Many accountants only guesstimate depreciation claims and tend to be more conservative, he says. "Most investors when they buy a property are thinking about capital growth and negative gearing. Many are surprised to learn about depreciation and doubly surprised at what they are able to claim," Beer says.
Indeed, most quantity surveyor firms are so confident that investors will profit from employing them that they are often prepared to refund their fee if they can't deliver substantial deductions.
Many investors also fail to realise that depreciation claims can be applied retrospectively. "Just as the ATO can request that you pay more tax after filing your return, investors are able to go back and amend previous tax returns in years where they think they have missed out on depreciation claims," Beer says.
WHERE INVESTORS GO WRONG
Property promoters and developers also love depreciation claims. Indeed, depreciation is often used as a key marketing tool to sell a property, particularly in off-the-plan developments. Anecdotally there are reports of some developers providing cost-plan estimates to investors that include depreciation claims of up to 30 per cent on items such as cornices, skirtings and paint, which are clearly non-depreciable from a tax point of view.
Andrew Gardiner, senior tax manager at the National Tax and Accountants Association, says inexperience among investors often leads to problems with depreciation claims.
"The problem is that investors are not often skilled enough to assess the value of the depreciable fitting," says Gardiner, who recommends investors employ the services of a quantity surveyor.
TAX OFFICE GETS TOUGH
With claimed tax deductions from residential landlords having ballooned to nearly $22 billion last year, the ATO is getting tough on dodgy claims. Whether claiming depreciation or a deduction, investors need to ensure they are accurate about what they claim.
ATO Assistant Tax Commissioner Megan Young says the Tax Office has written to 76,000 residential property investors who entered the rental market last year as part of an education campaign about residential property deductions. Another 45,000 individuals "at risk of not complying" have been reminded to check the accuracy of their claim before lodging their returns. A total of 6000 audits of residential property investors will be conducted this year.
Make sure your claims stand up. For a comprehensive list of depreciating assets in residential properties, see the ATO's Rental Properties 2006-2007 and Guide To Depreciation Assets 2006-2007 at www.ato.gov.au.
