Hidden Cashflow – Massive Depreciation Deductions - June 2024

By Guest Blogger, Mike Mortlock, Managing Director

MCG Quantity Surveyors

"Too many people get their tax deductions wrong each year and worse – don’t claim the maximum they are allowed."

ATO Assistant Commissioner Rob Thomson has declared rental property claims as one of the three main focus areas for the ATO this tax season. According to ATO data, 9 out of 10 rental property owners are making mistakes with their claims, especially when it comes to repairs and maintenance.

So, what should a savvy investor know to avoid these pitfalls and stay in the ATO's good books?

One common mistake is claiming costs as repairs and maintenance, which are immediately deductible (100% deductible), when they should actually be classified as capital expenses, which need to be depreciated over the asset's life.

So, what's the difference between these costs?

•    Repairs: These are replacements or renewals of worn-out or broken parts, like fixing a rusted gutter or replacing a part of a dishwasher.

•    Maintenance: These are costs to prevent future deterioration, such as painting a house exterior, oiling a deck, or servicing air-conditioning units.

Repairs and maintenance costs generally cover expenses that restore an existing asset.

On the other hand, capital costs are related to improvements to the property, such as installing a new driveway or air-conditioning system. Replacing an old asset with a new one counts as an improvement, even if the old asset was damaged or needed replacement.

Are all capital expenses treated equally? Not quite!

Depreciation rates depend on the expected lifespan of the asset:

•    Division 40 (Plant and Equipment): This includes items like blinds, curtains, ovens, range hoods, garage door motors, irrigation systems, and hot water systems. These items depreciate at varying rates, but generally faster than building structures.

•    Division 43 (Capital Allowance): This covers fixed components of the building structure and land improvements, such as concrete, timber, tiles, retaining walls, bricks, and most building parts. These costs are depreciated at 2.5% per year over 40 years.

Capital Allowance deductions are limited to properties constructed after September 16th, 1987. Many investment properties were built before this date, so is it still worthwhile to claim depreciation?

In the vast majority of cases, yes! If the property has had some renovations or extensions, we’re qualified to estimate the value of these works, and you’ll be able to claim the structural improvements carried out by the previous owner. Any improvements you make yourself are likely deductible as well.

If the property has been renovated or refurbished, either by you or a previous owner, the costs of these renovations may be eligible as a Division 43 deduction.

For example, let's say you buy a house built in 1975. It’s a solid brick home, but because it was constructed before 1987, the original structure is considered fully depreciated. However, unless the retro yellow laminate countertops and lino flooring are still there, the kitchen and bathrooms have probably been upgraded at some point in the last 30 years or so.

So even if you can’t claim a deduction on the original structure, there’s a strong chance you can claim depreciation for the cost of the upgrades. But if you didn’t own the property at the time, how do you know what was spent on these works? Determining the cost of renovations you didn’t complete yourself can be tricky, and that's where you need expert advice.

A qualified Quantity Surveyor will prepare a depreciation schedule for your investment property, outlining the estimated cost of any renovations and the relevant depreciation rates. There’s no doubt that a newer property will always return more deductions than a similar-sized older property, but let’s take a look at a case study to identify the differences.

Case Study:

Property 1: A 160 sqm brick and tile residence built this year, ready to be rented out on the 1st of July. The construction cost was $350,000 in total, which comprises:

•    $313,000 worth of building structure (Division 43)
•    $37,000 worth of plant and equipment items

The Division 43 is easy to calculate as it is 2.5% of the opening value of $313,000, so $7,825.00 each year. 

As we noted above the Division 40 items like ducted air conditioning, carpet, and cooking appliances all depreciate at different percentages. For example, carpet is depreciated at 25% under the diminishing method. In this example, the deductions came to $5,535 on the plant and equipment items in the first year, making a total claim of $13,360.

Property 2: A similar-sized property, which was originally constructed in 1981, was purchased this year ready for rental on the 1st of July. 

Prior to the current owner purchasing, the property had a few improvements and additions; an updated kitchen and bathroom, new carpet and blinds, as well as a back deck. 

These items are a mix of Division 40 and Division 43. For example, the timber deck is Division 43 depreciable at 2.5% of its value each year, while the kitchen is a mix of Division 40 and Division 43. The tiled floor in the kitchen is Division 43, while the cooktop, oven and range hood are Division 40 and depreciate at higher rates.

The property has a few original plant and equipment items. However, with the changes to plant and equipment deductions announced on the 9th of May 2017, none of these deductions are applicable any longer unless the asset is installed brand new by the owner or the property was purchased brand new. This applies to the new plant and equipment items as well, as these were installed by the previous owner.

The building improvements came to a total of $55,000, with $46,000 belonging to the building structure, and $9,000 belonging to the plant and equipment items. The net result being a first-year claim of:

•    Building Improvements: $1,150
•    Old Plant and Equipment: $0
•    New Plant and Equipment: $0
•    Total Claim = $1,150

As you can see, Property 1 is the pick in terms of deductions, with $13,360 of tax deductions compared to $1,150, resulting in a difference of $12,210. 

However, the deductions for Property 2 are still significant over time and definitely worth the cost of a depreciation report, which is itself a deductible expense. With the potential for tax back in your pocket, it makes sense to have a depreciation report completed as soon as you purchase so you can maximize your claims. In the current climate of record inflation, a dollar today will not be worth the same in two years’ time, so every year you hold off claiming depreciation could be costing you money.

MCQ Quantity Surveyors are passionate about helping investors maximise the return on their properties and have vast experience and national presence to help with your depreciation calculations and reports. Not only can we help you determine how much you can claim, but we’ll also make sure you’re classifying your deductions in accordance with the ATO guidelines.

Keeping everyone happy!

Contact us now for an obligation free quote on 1300 795 170 or go to our website mcgqs.com.au for more information.

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