Making improvements is all part of owning a property, whether it be a home or an investment. The difference with making an improvement to an investment property is that it can result in higher rental returns and depreciation deductions.
But do you know how to depreciate rental property improvements? And what is involved in doing so?
Understanding difference between improvement and repair
Before we get into the nitty-gritty of how to depreciate rental property improvements, it’s imperative to understand the difference between improvements and repairs as they are claimed differently.
An improvement is improving beyond what was there to start with, while a repair is bringing back what was there.
A repair can be claimed as an instant deduction while an improvement must be depreciated. Differentiating between the two is considered on a case-by-case basis and an accountant will look at a number of factors such as the asset installed, what was there before, the costs and the reasoning for the repair or improvement.
For example, replacing linoleum flooring with brand-new carpet would be considered an improvement as you’re replacing the previous asset with a new, higher quality one. But if you instead just replaced part of the linoleum floor with similar flooring it could be classed as a repair.
How to depreciate rental property improvements
How this is done depends on the type of improvement and what category of depreciation the improvement, or parts of it, fall under.
If the improvement is structural in nature or involves installing fixed assets like kitchen benchtops, tiles and doorknobs, then it needs to be depreciated using capital works deductions.
Capital works depreciate at a rate of 2.5 per cent per year for residential properties. This means a capital works renovation can produce valuable depreciation deductions for forty years.
But if the improvement includes easily removable or mechanical assets, then plant and equipment depreciation deductions must be used. These work differently as every plant and equipment asset has a designated effective life, so they depreciate at different rates based on the depreciable lifetime they are given.
Before any renovation an investor must remember that there are 2017 legislation changes in place that impact depreciation available on plant and equipment assets. It means that any second-hand plant and equipment asset purchased and installed after 9 May 2017 are ineligible for depreciation. Therefore, those looking to take full advantage of depreciation should avoid installing a second-hand plant and equipment asset during a renovation.
Some plant and equipment assets may also qualify for special incentives. One of these is the immediate write-off, where new assets that cost less than $300 can be claimed as an instant tax deduction rather than depreciated over time.
The second incentive on offer is the low-value pool. This allows new assets that are installed during an improvement to be depreciated at an accelerated rate if they are valued at less than $1,000.
It’s also important to remember that anything removed during a renovation can be ‘scrapped’. This means any undeducted depreciable value of a removed asset or structure can be claimed as an instant deduction in the same financial year.
Now that we know how an improvement depreciates, how can it be claimed as a tax deduction?
The key to claiming this depreciation on property improvements is to use a tax depreciation schedule.
This essential report outlines every single depreciation deduction claimable from the rental property. An accountant uses this schedule at tax time each year to determine the depreciation deduction to reduce the financial year’s taxable income.
What happens if an improvement is made after a tax depreciation schedule has already been prepared?
Rental property improvements are made for a variety of reasons. One could be made due to damage or damage prevention, or simply a renovation to improve the rental return of the property.
Whatever the case, the good news for investors that have an existing schedule with BMT is that it’s easy to make amendments to a current schedule to ensure the improvement and its assets are included.
Now that you know how to depreciate rental property improvements and what’s needed to do so, contact BMT today on 1300 728 726 or Request a Quote.