Renovate and Depreciate
When purchasing an older investment property, many investors decide to renovate after settlement. Investors can often claim thousands of dollars in deductions when renovations are done.
Get more when you Renovate
Has the time come to renovate an investment property? Make sure you do everything to maximise the cash flow potential of your next renovation project. Thinking about the types of new fittings and fixtures before you install them may generate you thousands of dollars in depreciation deductions.
Many investors purchase properties that require improvement. They usually do this with the sole purpose of renovating to create equity and generate extra rent. Once you have decided to renovate your investment property, it is important to ensure you obtain the best long term value from the money you are outlaying. Renovations can be expensive, so it makes financial sense to obtain the maximum depreciation benefit where possible. When it comes to deciding which new item to install in a property, some consideration should be applied to the depreciation potential of the alternative item/s.
Maximising depreciation on new items
1. Floor Coverings
Which new floor covering should you install to increase your depreciation potential - carpet, floating timber floorboards or tiles? The depreciation available on these items differs due to their different effective lives.
The following example is based on spending $2,000 on floor coverings:
2. Light Fittings
Considering ornamental light fittings or down lights?
The following example is based on spending $2,000 on lighting::
3. Air Conditioning
Deciding between an air conditioning unit and ducted air conditioning?
The following example is based on spending $5,000 on cooling:
(Amounts based on Diminishing Value Method using current legislation)
As shown in these examples, installing assets for their depreciation potential is certainly worthwhile. Depending on the size of the property and the extent of the renovations, the deductions obtained from the new items may improve your cash flow in the first years of ownership by thousands of dollars each year.
Effective lives explained
The effective life of an asset is used by a Quantity Surveyor to work out an asset's decline in value.
The Australian Taxation Office (ATO) describes an effective life of an asset as:
‘the period of time that a depreciating asset can be used by any entity to produce assessable income:
- assuming it will be subject to wear and tear at a reasonable rate,
- assuming it will be maintained in reasonably good order and condition, and
- having regard to the period within which it is likely to be scrapped, sold for no more than scrap value or abandoned.’*
Depreciation deductions on structural renovations
If structural construction work is completed as part of the renovations (such as a new roof, walls or ceiling), this can also be depreciated. Any work carried out after 18 July 1985 (residential property) or 20 July 1982 (non-residential property) will be eligible to claim the capital works allowance (Division 43).
Renovations carried out by previous owners: Can depreciation be claimed?
When BMT Tax Depreciation completes your tax depreciation report, we always take into consideration the renovations carried out by previous owners. Even though you have not carried out the work yourself, there may be depreciation deductions for you to claim. A thorough site inspection is undertaken on your property by a BMT Tax Depreciation staff member identifying previous renovation works. Further council searches can also reveal details of previous renovations carried out on the property.
I’ve done a renovation myself. Can I claim my personal labour?
You can only claim depreciation for renovations on the amounts that you have spent. If you have taken the time to complete the renovation yourself or have completed sections yourself there cannot be any monetary allowance made for your own personal labour.
Similarly if you obtain a great deal on any plant and equipment items (for instance you obtain an oven that normally retails for $3,000 for $999 off the internet) you can only claim depreciation entitlements on the actual amount that you have spent.
Depreciation pre and post-renovating
Prior to demolition or renovation, many investment property owners remain unaware that the existing assets within their property can be worth thousands of dollars. When these assets (e.g. carpet and hot water systems) are replaced or ‘scrapped’, owners may be entitled to claim them as tax deduction. Before you discard existing items or demolish your investment property, check to make sure you aren’t throwing dollars away!
How does an investor benefit by scrapping?
Scrapping of existing plant and equipment can provide additional tax credits for investors who demolish or dispose of existing buildings or any part of it which was owned as an investment asset and eligible to produce income.
To calculate the scrapping value if the existing written down value is not known, the quantity surveyor or client’s accountant identifies the items that were removed or scrapped in the renovation process.
Why scrap items?
There are several reasons why an item can be scrapped. These include:
- Obsolete;
- Functionally inadequate;
- Dated style;
- Original form was inappropriate or does not maximise the form and function of the property; or
- Additional value to the owner is obtained from a renovation.
To maximise a scrapping claim, focus should be given to items classified under Division 40 ('plant & equipment') as these items have the highest depreciation claim and often the greatest individual value.
It is important to note that a valuation of all items is required, including those to be retained and those to be scrapped in the refurbishment process, with adequate photographic records retained for evidence of justification.
The concepts outlined above can provide the property investor with a very attractive tool to maximise the tax benefits available from the refurbishment of an existing building in the future.
Many investors remain unaware that pre-renovation/demolition investment properties contain depreciation deductions. If you are unsure about your entitlements, contact BMT Tax Depreciation before you start any renovation/demolition. You may be able to obtain thousands of dollars in depreciation deductions you never new were available.
* Source: www.ato.gov.au