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When a quantity surveyor completes an investor’s capital allowance and tax depreciation claim, two main elements are taken into consideration;
- Capital Works Allowance (Division 43) and
- Plant and Equipment (Division 40).
Capital Works Allowance: The capital works allowance is a deduction available for the structural element of a building including fixed irremovable assets; this is commonly referred to as the building write off. Only some properties will qualify for this allowance, depending on the age of the building.
Plant and Equipment: The plant and equipment element is a deduction available for removable assets which are identified through Australian Taxation Office (ATO) legislation as assets which depreciate at a faster rate than the building. Each plant and equipment item has an effective life and the depreciation available on that item is calculated accordingly.
Capital Works Allowance: Historical Calculations
When an investor purchases a property there is often no information available that outlines what the building originally cost to construct. To calculate the capital works allowance the ATO requires that either the original construction cost be used or an estimate of the construction cost is obtained, which will reflect the cost at the time the building was built. This is commonly called the historical construction cost.
The capital works allowance available on a property is determined from the date of commencement of the construction works. All income producing buildings, refurbishments, extensions and fit-outs that have commenced within the qualifying time periods are eligible to claim the capital works allowance. The following graph demonstrates the qualifying dates and the rate the capital works allowance (Division 43) is claimed at.
Some buildings will not qualify for the capital works allowance due to their age. For example, as can be seen from the graph, an original residential building constructed pre 18 July 1985 will not qualify for the capital allowance. However, if a renovation or extension has been completed since 18 July 1985, the building allowance can be claimed for those works.
Rate of Building Write Off
As the graph illustrates, the date of construction of a building or renovation determines if the capital allowance is depreciated at a rate of 2.5% or 4.0%. Where the capital allowance is depreciated at a rate of 2.5%, it can be claimed for 40 years from the date of construction completion. Alternatively, where the capital allowance is depreciated at a rate of 4.0%, it can be claimed for 25 years from the date of construction completion.
Establishing the historical construction cost
Older buildings which do not qualify for the capital works allowance will still attract a tax credit for the depreciation of plant and equipment which can be claimed regardless of age.
Example 1:
House Built 1986 (qualifying for Division 43)
Renovation Completed 1994 (qualifying for Division 43)
Settlement Date: 30/06/2007
As outlined previously, the 1986 original construction work can be written off at 4.0% and the 1994 renovation can be written off at 2.5% per financial year.
BMT & ASSOC estimates the 1986 historical construction cost at $160,000
Calculation:
Written off @ 4.0% = $6,400 per year for 25 years
Balance:
As the property was built in 1986 and the capital allowance can be claimed at 4.0% for 25 years from date of construction completion, the investor will have 4 years of capital allowance left to claim = $25,600
BMT & ASSOC estimates the 1994 renovation construction cost at $25,000
Calculation:
Written off @ 2.5% = $625 per year for 40 years
Balance:
As the renovation was completed in 1994 and the capital allowance can be claimed at 2.5% for 40 years, the investor will have 27 years of capital allowance left to claim = $16,875
Example 2:
House Built 1997 (qualifying for Division 43)
Settlement Date: 30/06/2007
BMT & ASSOC estimates the 1986 historical construction cost at $160,000
Calculation:
Written off @ 2.5% = $5,000 per year for 40 years
Balance:
As the property was built in 1997 and the capital allowance can be claimed at 2.5% for 40 years from date of construction completion, the investor will have 30 years of capital allowance left to claim = $150,000
It is important to remember that older buildings which do not qualify for the capital works allowance will still attract a tax credit for the depreciation of plant and equipment (Division 40) which can be claimed regardless of age.
Quantity Surveyors are recognised by the ATO under TR 97/25 as appropriately qualified to estimate construction costs of a building for capital allowance and tax depreciation purposes. As a lot of investment properties are not brand new, it is important to accurately estimate the historical construction cost in order to maximise the tax credits available.
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