While accountants are familiar with property depreciation and the rules that should be followed when lodging their clients’ annual income tax assessments, the same can’t always be said for rental property owners.
Depreciation, which is a non-cash deduction relating to the wear and tear of an income-producing building and the assets it contains, can be a complex topic for investors to understand.
There are a number of errors taxpayers can make when claiming. Below are some of the areas where investors get it wrong and the corresponding advice accounting professionals can provide to help steer them in the right direction to ensure their claims are correct and accurate in the future.
They don’t claim deductions for older properties
One mistake investors tend to make when it comes to depreciation is assuming an older property will no longer have any deductions available to make a claim worthwhile.
While legislation enforced by the Australian Taxation Office does outline some restrictions regarding the construction date of the property, this doesn’t necessarily mean owners of older properties will not benefit from claiming depreciation.
This is because depreciation is broken into two categories – capital works deductions and plant and equipment depreciation.
Capital works deductions apply to the structure of the building and any fixed items, while plant and equipment depreciation can be claimed for any of the mechanical or easily removable fixtures and fittings found within the property.
The rules state that owners of residential properties can only claim capital works deductions for properties constructed after 15 September 1987. In commercial properties, this date is 20 July 1982. However, it is rare to find a property that has been constructed prior to these dates that has had little or no work completed after its original build.
Any structural work completed to a residential or commercial property within the legislated dates could entitle its owner to capital works deductions, even if the work was completed by a previous owner.
For plant and equipment assets, there are no such date restrictions. Their value is determined by the condition, age and quality of each individual asset. A fair value should be ascertained and each item should be claimed based on its individual effective life. This effective life will start from the date of settlement.
They claim capital works and plant and equipment incorrectly
As there are two categories when depreciating property, this can lead to incorrect claims being lodged, particularly if an investor doesn’t seek appropriate advice.
Investors who self-assess depreciation deductions often make one of the two mistakes:
- They claim structural items as plant and equipment; or
- They claim plant and equipment as capital works deductions.
As the depreciation rates used to calculate deductions and the period of time over which capital works items and plant and equipment depreciate vary, this can result in the following outcomes:
- By claiming structural items (which depreciate at a rate of 2.5 per cent over a maximum of 40 years) as plant and equipment, owners could over-claim and put themselves at risk should the ATO conduct an audit;
- By claiming plant and equipment items using the rate for capital works deductions, investors could under-claim and miss out on substantial deductions; and
- They may not apply an immediate write-off or low-value pooling to eligible items.
They get confused between repairs and maintenance and capital works improvements
An area often on the ATO’s watchlist, where investors can easily find themselves making errors, is mistaking repairs and maintenance with capital improvements and vice versa.
The ATO provides clear definitions of each of these terms which accountants can explain to help their clients to decipher how work completed to a property should be claimed.
Repairs are considered work completed to fix damage or deterioration of a property, for example replacing part of a damaged fence. Maintenance is work completed to prevent deterioration to a property, for example oiling a deck.
Any costs incurred for repairs and maintenance of a rental property can be claimed as a 100 per cent immediate deduction in the year of the expense. However, if any work completed enhances the condition or state of the item beyond its original state at the time of purchase, this is considered a capital improvement.
Capital improvements must be classified as either a capital works deduction and claimed over time or claimed as plant and equipment depreciation.
If existing items have any remaining depreciable value, the owner could be entitled to claim what is known as ‘scrapping’. Scrapping allows the owner to claim any remaining depreciable value for structures or assets removed in the year of the items removal.
They aren’t aware that co-ownership influences how depreciation should be calculated
As housing prices continue to rise, more investors are joining forces with family and friends to purchase investment properties.
Co-ownership opens doors for investors by increasing their buying power and reducing the burden of purchase costs and ongoing expenses such as rates, repairs and maintenance. As such, accountants need to make their clients aware that ownership structures influence how property depreciation should be calculated.
When applying depreciation legislation to assets within co-owned properties, the cost threshold that qualifies assets for accelerated depreciation rates can be governed based on each owner’s interest in the asset. However, it’s often more beneficial to calculate each owner’s interest in the individual assets value first and apply the depreciation rules accordingly.
Legislation allows property investors to claim an immediate write-off for assets with an opening value of $300 or less. In a situation where ownership is split, an accountant can apply this rule and claim an immediate write-off to items where an owner’s interest in the asset is below $300.
Where an owner’s interest in an asset is $1,000 or less, these items will qualify to be placed in a
low-value pool. Pooling is a method of depreciating plant and equipment assets at a higher rate to maximise depreciation deductions. Investors who decide to place assets into a low-value pool can claim them at a rate of 18.75 per cent in the year of purchase and 37.5 per cent for each year afterwards.
When qualifying assets for immediate write-off or the low-value pool, the value of the asset can be distributed based on the percentage of ownership. This increases the number of assets that qualify.
In a 50-50 ownership situation for a residential property for example, by splitting an owner’s interest in each asset, the owners can claim items up to a total value of $600 as an immediate write-off. An asset that is valued or costs less than $2,000 will now qualify for the low-value pool and the owner can take advantage of the increased rates of depreciation available for pooled assets.
Ultimately, the deductions an investor receives from a maximised depreciation claim are essential to boosting their cash flow.
Providing an investor with some basic knowledge about depreciation will not only help them turn a negative cash flow scenario into a positively geared asset, it will also help accountants to extend their existing services and add additional value, encouraging repeat business.
Brad Beer, chief executive, BMT Tax Depreciation
