Investors fail to appreciate depreciation

Posted on 20/06/2008  

Since it will soon be tax time, we should mention that experts estimate that one out of two investment property owners are not claiming legitimate tax deductions on their rental properties.

Tax depreciation specialist TDS says investment property owners who are thinking of selling because of rising interest rates should first make sure they are claiming all of their depreciation deductions.

TDS partner Jodie Eade says depreciation deductions can range from $10,500 for a pre-1985 three-bedroom house to $52,000 for a new, two-bedroom inner-city unit over a five-year period.

"The really good news is you can backdate claims for four years when you haven't claimed legitimate depreciation costs," Eade says.

The Australian Taxation Office is holding several billion dollars in unclaimed depreciation rebates and the ATO itself has said that 52% of investment property owners do not claim for tax depreciation on their properties. Why is this so?

Well, depreciation works most effectively for you if you pay for a quantity surveyor to prepare a schedule (costs vary but usually less than $1,000 for what is a one-off, tax-deductible expense). The property owner then attaches the schedule to his tax return and leaves the rest to the accountant. Most standard capital items in a rented house or unit qualify for depreciation - carpets, curtains, stoves, washing machines, microwave ovens, hot water systems, air conditioning units - the list goes on.

Of course, a range of household items and fixtures do not qualify for depreciation. These include doors and windows, floor and wall tiles, plumbing and gas fittings and sinks, tubs, baths, wash basins and toilet bowls.

The ATO produces a useful document outlining what is and is not deductible when it comes to rental properties. One would have to tread carefully as the tax law is continually being tweaked and changed. But we found some interesting things in the ATO document called Rental Properties (2007).

For example, an item bought for a rental property and intended to be used by a tenant is fully deductible in the year of purchase providing it is worth $300 or less (a video recorder or set top box would fit this description). This provision was introduced to allow landlords an immediate one-off deduction for common low-cost household items - handy when the toaster or kettle fails and the tenant demands a replacement.

The parsimonious landlord might realise that it is possible to depreciate second hand items of plant bought for use in a rental property (or inherited by virtue of buying an older property). This is where a depreciation audit comes in handy - if you have just purchased an older house to rent out, the residual value of the existing stove, hot water system, etc need to be established to prepare a depreciation schedule.

The idea of depreciation is to allow landlords to plan and budget for replacement of household items which wear out over fixed time periods. There are two methods of depreciating capital items - ‘prime cost' and ‘diminishing value'. Using the prime cost depreciation method, the same amount is deducted as depreciation each year. So, for example, an item costing $1,000 and depreciating at 20% of the prime cost will depreciate at $200 each year for five years (and can be ‘written off' after five years). The diminishing value method uses a higher rate of depreciation, but works out depreciation each year on the diminishing residual value of the item. This means that a greater amount of depreciation can be claimed in the earlier years of depreciation, but a lesser amount as the item decreases in value.

Depreciation is a complex area of tax. A landlord with a grasp of the concept may be able to prepare and maintain a depreciation schedule, but it is highly advisable to leave to your accountant such tasks as choosing the most advantageous method of depreciation.


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