Depreciation of pre-purchase additions and improvements
Please note that his article has now been updated and replaced following the Budget 2017.
Many homes, particularly those that are older, have undergone some capital improvements and additions over time. Investors may be wondering how they can claim tax depreciation for work that was done to their investment property by previous owners, if they do not know the dates and costs of those works. This is where a suitably qualified quantity surveyor brings additional value to your investment. Quantity surveyors are recognised by the ATO to be suitably qualified to estimate construction costs at a given point in time. The experience and research skills of your quantity surveyor will be able to effectively date and cost the works of a property, and produce a timeline of the history of that property, for the purpose of calculating capital works or tax depreciation deductions.
What this means to the investor, is that most of the improvements and additions completed on a property over time, even by previous owners, become eligible for tax depreciation for the current owners. The more substantial and recent the improvements and additions have been made, the greater the deductions claimable.
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The purchasing of older or “cosmetically tired” properties for improvement and holding has becomes a very popular and often rewarding strategy for many property investors. The great news for investors in search of the “doer-upper” for investment purposes, is that all the work you do to improve the property in preparation can be eligible for tenants, increases depreciation, increasing the tax depreciation claims deductions available to you for that property.
The decision about what types of improvements an investor will make to maximise their return on investment is influenced by many factors including budget, costs, target market, durability and style. An additional factor worth considering is the tax depreciation claims that a particular type of improvement or addition will generate. For example, when considering floor coverings, carpet as a Division 40 plant and equipment asset, with a shorter effective life, depreciates at a faster rate than floor tiles which are Division 43 construction asset. This means that carpet will attract a higher rate of depreciation in the earlier years, and depending on cost differentials, is likely to generate higher deductions for the investor earlier on. Additionally, higher spec fixtures and fittings will may cost more at the outset, but can generate larger deductions at tax time.
What many investors may not have considered is the value of the items they are throwing or giving away. You may be thinking that the old bath tub, or kitchen cupboards, or carpet and blinds are so old that there is no value left in them anyway, but you will be surprised. Any effective life technically still existing within the assets has a value, and the value becomes an immediate write-off when the item is scrapped. That’s right…that old carpet, tired curtains, dated kitchen cupboards and sink that just got hauled away in the skip, could have a combined value of a few thousand dollars that can be claimed as a deduction (Disposal of Assets or Scrapping) straight up in the first financial year. The key to utilising this nifty strategy is to ensure that your quantity surveyor can value those items. This can be done via a pre-renovation inspection, or via photos and notes taken of the assets prior to removal. It is common for investors to claim up to $5,000 for "scrapping" for a reasonable renovation. Some clients have even claimed up to $100,000! Combined with the claims of your new assets, the scrapping of old assets makes a great contribution to keeping your tax down at the end of financial year.
And...we don't charge extra to include scrapping to our Tax Depreciation Schedules. Most of our competitors do, so if you have renovated, or plan on renovating, be sure you don't end up paying extra when it comes time to order your Tax Depreciation Schedule.
Examples of effective lives to consider when renovating – remember shorter effective lives = higher depreciation rates.
An investors own labour in completing renovations or additions, or the unpaid labour of family and friends cannot be included in calculating the depreciable construction cost.
Fees paid to a third party for labour carried out when renovating are eligible to be included in the construction costs.
The legislation surrounding tax depreciation requires that actual costs are used, where those actual costs are known or available. This means that where assets have been purchased by the investor at a discount, it is the discounted cost that is included for tax depreciation purposes.
As stated above in Assets Purchased at a Discount, tax depreciation legislation states that actual costs must be used where those costs are known, or available. When an investor does not recall the costs of an asset, and does not have evidence of the cost (e.g. a receipt), quantity surveyors are qualified to estimate those costs, based on their research of the market costs of those assets at the time of purchase and installation.
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