Property owners will often move in and out of a property, changing it from a main residence to an investment and vise versa.
At BMT, we hear many clients asking questions about the implications this has on depreciation. In this article, we discuss how this works.
Plant and equipment depreciation implications
Let’s start with the depreciation implications on the easily removable or mechanical assets in an investment property, known as plant and equipment. Examples include floor coverings, hot waters systems, air conditioning units and light fixtures and fittings.
Since legislation changes came into play in late 2017, depreciation on pre-existing plant and equipment assets in residential second-hand investment properties can no longer be claimed.
The key factor here is the ‘previously used’ provision – any existing plant and equipment assets will be deemed second-hand. The previously-used provisions also apply to brand-new assets installed while an owner lived in a property, and brand-new assets that existed before the owner moved into and out of the property.
This means that if an investor has lived in their rental property for any length of time after 1 July 2017, all existing plant and equipment assets are ineligible for depreciation deductions.
So, if an investor is both renovating and looking to maximise the tax deductions on their property, we would recommend they avoid living in the property during the renovation to make sure depreciation can be claimed in full.
However, in the instance where the ‘incidental or occasion’ exception applies, an investor could still claim full depreciation if they have temporarily stayed at the property. This is a very grey area and the tax commissioner usually considers this to be a few nights or weeks, but it is based off the individual scenario.
Capital works depreciation deductions
The second, and usually largest, part of any depreciation claim is capital works deductions. Capital works depreciation deductions can be claimed for the wear and tear of a building’s structure and permanently fixed items, over a period of forty years.
The 2017 legislation changes don’t impact capital works depreciation deductions, these deductions simply become unavailable during the period the investment is lived in by its owner.
For example, if a property was built in 2000 then capital works deductions on the original structure cost are still available until 2040. However, if the owner lived in the property from 2010 to 2015, they will miss out on claiming those five years’ worth of capital works depreciation deductions.
Living in an investment then making a substantial renovation, what happens?
The Australian Taxation Office defines a substantial renovation as:
“substantial renovations of a building are renovations in which all, or substantially all, of a building is removed or is replaced. However, the renovations need not involve removal or replacement of foundations, external walls, interior supporting walls, floors, roof or staircases.”
When a property is substantially renovated most rooms in the property are affected and many depreciation deductions that weren’t there before are now available from new assets and structures.
However, it’s crucial to remember that even during a substantial renovation an investor intending to rent the property out shouldn’t live in it during this time. This will create the same issue of the new plant and equipment assets being classed as previously used.
But what happens when an investor purchases an investment property that has been substantially renovated? If the renovation took place immediately before the sale, then all depreciation deductions will be available, as if the property is brand-new.
If the property was rented between the time it was substantially renovated and sold, the new owner needs to establish just how long it was previously rented for and if the previous owner claimed depreciation over that time.
If this period exceeds six-months or depreciation was claimed on the assets, then the 2017 legislation changes will apply, removing the ability for the owner to claim depreciation on the plant and equipment. However, if the property is renovated, rented, and sold within a six-month time frame with no claim by the previous owner, then all depreciation deductions are up for grabs by the new owner – including the plant and equipment items installed during the renovation.
For more information on the depreciation implications of living in an investment, call BMT today on 1300 728 726.