Tax deductions for depreciation is certainly not the only thing, or even the most important thing that investors need to consider when purchasing an investment property.
However, understanding the benefits and impact of depreciation on cash flow and therefore the holding costs of an investment property can be helpful when it comes to property selection criteria, budgeting and cash flow forecasting.
When comparing similar properties purchased today, brand new properties will typically generate greater tax deductions for depreciation than older established properties.
This is the case for a few key reasons:
Brand new properties have higher construction and assets costs from which to calculate annual depreciation
Building depreciation (Division 43 deductions) are calculated as a percentage of the total construction cost (including consultants fees and preliminaries such as site management, temporary fencing, portaloos, cranes, site sheds etc).
As construction costs increase over time, the total construction costs of new buildings are greater than the total construction costs of older buildings (as they are costed as at the time they were built).
Working from a higher total build cost the annual depreciation claimable at 2.5% is greater for brand new buildings.
Brand new buildings and assets still have their full "effective" or working lives remaining to be depreciated. For assets that have much shorter effective lives than buildings the benefit of brand new is even greater. These assets can often be depreciated at accelerated rates depending on their cost and the method of depreciation used.
All of the assets included in a brand new property are eligible for annual depreciation deductions for the owner. Depreciation of second hand assets however, can only be claimed as a lump sum expense at the time of sale, so they do not assist with increased cash flow during ownership.
Table comparing the differences:
Graph comparing brand new, 2 bedroom unit depreciation with similar unit that is 2 years old:
The graph above shows the cumulative depreciation claimable over 5 years for a brand new 2 bedroom unit (blue), and a similar unit that is two years old (green). Total tax deductions for capital allowance and depreciation over the 5 years for the brand new unit is $61,496, whilst for the 2 year old unit the total deductions over the same time is $32,500.
Impact on cash flow:
Graph comparing brand new, 3 bedroom townhouse with similar townhouse that is 2 years old:
The graph above shows the cumulative depreciation claimable over 5 years for a brand new, 3 bedroom townhouse (blue), and a similar townhouse that is two years old (green). Total tax deductions for capital allowance and depreciation over the 5 years for the brand new unit is $60,434, whilst for the 2 year old unit the total deductions over the same time is $38,750.
Impact on cash flow:
It is clear from the examples above that brand new property does generate greater tax deductions in the way of capital allowance and depreciation, than comparable older properties.
Exceptions to this rule could occur where an older property undergoes an extensive, expensive, high finish renovation with additional construction and installation of brand new assets.
It is also important to note, that whilst brand new property typically outperforms older property in terms of higher depreciation, the tax deductions available for depreciation of older properties can still be substantial and it is worth having a depreciation schedule prepared. For these properties, not only does a depreciation schedule ensure you are effectively claiming the maximum deductions for any original and subsequent construction works, it also means that the future deductions claimable for depreciation of the assets at sale have been maximised and accurately recorded.
As always we recommend seeking personalised advice regarding investment property depreciation from our expert team at Capital Claims Tax Depreciation. Contact us for a free estimate of depreciation for your investment property on 1300 922 220 or visit our website for more information.
Mark is an expert quantity surveyor, business owner, public speaker and property developer. With 20+ years experience in the construction and quantity surveying industry Mark’s specialist expertise have been sought in consultant capacity by professional bodies such as the National Institute of Accountants and the National Tax and Accountants Association, and he has presented at various property and tax seminars and expos nationwide. Mark holds a Bachelor of Construction Management from the University of Newcastle, is an affiliate member of the Australian Institute of Quantity Surveyors and a Registered Tax Agent.View all posts by Mark Wilkins