A growing number of investors are choosing to renovate their investment properties each year. Master Builders Australia has forecast homeowners and investors will spend $8.8 billion annually on renovations over the next five years. Renovations can increase rental yields and improve cash flow however there are many important factors to consider before getting started. One of the most crucial aspects to consider is the effective life of depreciating assets.
The effective life of depreciating assets
Plant and equipment assets are items which are easily removable from the property such as carpet, hot water systems and blinds. The effective life is used to work out the asset’s decline in value for which a depreciation deduction can be claimed. Each asset also has a rate of depreciation which helps to determine the deductions an investor can claim over the asset’s effective life.
Investors can claim depreciation deductions for more than 6,000 different assets recognised by the Australian Taxation Office. With so many assets to choose from, it’s important to understand how variations in effective life can alter the depreciation deductions available.
We look at flooring, window covers and lighting to help you choose the most valuable assets when renovating your investment property.
$4,000 worth of carpet = $1,000 in depreciation deductions
$4,000 worth of floating floorboards = $533 in depreciation deductions
$4,000 worth of tiles = $100 in depreciation deductions
$3,000 worth of curtains = $1,000 in depreciation deductions
$3,000 worth of blinds = $600 in depreciation deductions
$3,000 worth of plantation shutters = $75 in depreciation deductions
$750 worth of light shades = $300 depreciation deductions
$1,800 worth of downlights = $45 in depreciation deductions
Effective life of depreciating assets for flooring
Carpet has an effective life of eight years. Using the Diminishing Value (DV) method, a rate of 25 per cent is used. If a landlord installs carpet worth $4,000, they will be eligible to claim $1,000 in depreciation deductions in the first full financial year. However, if they install floating floorboards or tiles of the same value, the available deductions will be $533 and $100 respectively.
In this scenario, an investor who installs carpet will be able to claim the highest depreciation deduction, while the investor who installs tiles will be eligible for the least.
Effective life of depreciating assets for window covers
Blinds have an effective life of ten years and a DV rate of 20 per cent. If a landlord purchases blinds worth $3,000, they will be eligible to claim $600 in depreciation deductions in the first full year. If they install curtains of the same value, the first-year claim would increase to almost $1,000.
On the other hand, if the landlord decides to purchase plantation shutters, which have an effective life of forty years and a DV rate of 2.5 per cent, the first year deduction would be just $75. With this in mind, curtains are the most valuable asset from a tax perspective.
It’s important to note that blinds and curtains may be eligible for low-value pooling. Low-value pooling is a method of depreciating plant and equipment assets which have a value of less than $1,000. Any plant and equipment assets with a value of less than $1,000 can be included in a low-value pool and written off at an accelerated rate to maximise deductions. Items can be depreciated at 18.75 per cent in the first year and 37.5 per cent each year thereafter.
Effective life of depreciating assets for lighting
Light shades have an effective life of five years and a DV rate of 40 per cent, while downlights have an effective life of forty years and a DV rate of 2.5 per cent. If the landlord installs $750 worth of light shades, they will be eligible to claim $300 in the first full year.
Let’s compare this to a scenario where an investor decides to install downlights. An investor will typically need to install more downlights than light shades. For this reason, the investor purchases $1,800 worth of downlights. Based on the effective life and DV rate, the investor would only be able to claim $45 in depreciation in the first full year.
As a result, light shades offer better depreciable value. As with window covers, lighting may also apply for low-value pooling.
Important depreciation legislation
It’s important to note that legislation passed in November 2017 brought about major changes to residential plant and equipment depreciation claims. Under current legislation, owners of second-hand residential properties who exchanged contracts after 7:30pm on 9th May 2017 cannot claim deductions for previously used plant or equipment assets.
If an investor lives in their rental property while renovating, any newly installed assets will be classed as previously used. Therefore, the investor is potentially risking their tax benefits. Unless there is good reason, investors who are planning on installing new plant and equipment assets should make these additions after they move out of the property and it has been listed for rent.
The 2017 legislation does not affect buyers of brand-new property, residential properties considered to be substantially renovated or commercial properties. With this in mind, brand-new property generally holds the most lucrative value for investors from a tax perspective.
Capital works deductions for structural assets such as new walls, kitchen cupboards, toilets and roof tiles are also unaffected by the legislation changes and can still be claimed by owners of income-producing properties.
When removing structural assets there may be remaining depreciation deductions available. A process known as scrapping can often be applied, allowing investors to claim these deductions in the year the items are removed.
To find out more, contact a specialist quantity surveyor to organise a tax depreciation schedule before starting renovations.