BMT Tax Depreciation are often asked what investors can do to increase tax deductions and boost cash flow.
One way is to renovate! Investment property renovations increase tax deductions, help with increasing a property’s value and improve rental yield leading to greater returns.
This article outlines the different types of investment property renovations, what to look out for and how to maximise tax deductions.
- Depreciation explained
- Greater returns
- Repairs, maintenance and capital improvements
- Previously used plant and equipment can’t be claimed
- Renovations completed by a previous owner
- Cosmetic versus substantial renovations
- Maximise the tax benefits with depreciation
Depreciation is the natural wear and tear of a property and the assets within it over time. The Australian Taxation Office (ATO) allows owners of income-producing properties to claim this as a tax deduction.
There are two types of deductions available to claim. Capital works deductions (Division 43) is a claim available for the building’s structure and the assets that are permanently fixed to the property. And plant and equipment depreciation (Division 40) is a claim on the assets that are easily removable from the property or mechanical in nature.
Capital works deductions are a fixed amount that can be claimed each year on all applicable building structures for up to forty years. Plant and equipment items have varying effective lives and therefore can be depreciated at an increased rate which varies depending on the asset and the method used to calculate the claim.
Renovating an investment property will not only heighten depreciation deductions but can also increase the capital growth and rental return. Even updating the flooring, adding a fresh coat of paint and updating areas like the kitchen or bathroom can attract better quality tenants and increase rental return.
The case study below demonstrates a scenario where an investor completed a $65,000 renovation.
Here is the investor’s scenario before and after completing the renovation
• Original purchase price (before renovation) = $610,000
• Rental income per annum prior to renovation = $20,580
• Total renovation spend (completed in 2021) = $65,000
• Property value on completion = $785,000
• Rental income per annum after renovation = $27,040
Due to the renovations completed the property’s value increased by $175,000 and yielded an additional $6,460 per annum in rental income to.
Repairs, maintenance and capital improvements
Knowing the difference between repairs, maintenance and capital improvements is particularly important when renovating.
According to the Australian Taxation Office (ATO), repairs are considered work completed to fix damage or deterioration of a property, such as replacing part of a damaged fence. This occurs when an asset is already damaged or deteriorated and therefore requires repairing.
Maintenance, on the other hand, is work completed to prevent damage or deterioration of an asset. For example, oiling a deck is considered maintenance as it helps to preserve the quality of the property and prevent future corrosion.
The total cost incurred to repair or maintain your investment property can be claimed as an immediate tax deduction in the year of the expense. However, the ATO specifies that initial repairs for damage that existed when the property was purchased does not always qualify for repairs and maintenance and therefore not always 100 per cent is claimable in the first year. Instead, these costs are treated as capital improvements and depreciated as capital works deductions or depreciation of plant and equipment.
A capital improvement is considered any works that improve a property beyond its original state. According to TR 97/23, an ‘improvement’ provides a greater efficiency of function in the property – usually in some existing function.
Some indicators that the work performed is an improvement include whether the work will:
• extend the property’s income-producing ability
• significantly enhance its saleability or market value, or
• extend the property’s expected life
For investors who already possess a BMT depreciation schedule and would like to update minor upgrades they can do this via email, the MyBMT portal or a phone call.
Previously used plant and equipment can’t be claimed
Residential property investors completing renovations should be aware of the 2017 legislation changes. The legislation stipulates that investors who purchased property after 7.30pm on 9 May 2017 are unable to claim deductions for the decline in value of previously used plant and equipment found in second-hand residential properties. But these investors can still claim depreciation on new plant and equipment assets added to a property and all structures new and old as capital works deductions.
It’s common for investors to live in their property while renovating. While this may seem like a good idea, all plant and equipment assets like air-conditioning units, light fittings and hot water systems will be classified as previously used and no longer be eligible for depreciation deductions due to the legislation changes.
Assets may be removed while there is remaining depreciable value left over, claiming this un-deducted value is commonly referred to as ‘scrapping’.
Scrapping value is essentially the un-claimed or un-deducted depreciable value of an asset at the time of removal. The scrapping value is calculated as follows:
Scrapping value = original depreciable value – deducted value to date
For example, if the original value of an asset or part of a building was $8,000, and $6,000 was claimed by the time of the asset’s disposal, the ‘scrapping value’ or part of a building would be $2,000 (assuming no amount is received on disposal). The owner could then claim the $2,000 as an instant tax deduction in the same financial year as removal.
It’s important to talk to a quantity surveyor before removing any items so they can capture the assets available for capital works or plant and equipment depreciation deductions.
Renovations completed by a previous owner
Many older properties have had renovations completed by previous owners, these works are often qualifying and can be claimed by current owners.
For instance, if a property was built in 1979 but renovations were completed in 1993 the capital works for the renovation are eligible for depreciation deductions. Even though the property itself is older than forty years, there are still eleven years left of depreciation deductions on the work completed by previous owners.
Data shows that of all the schedules completed by BMT, 66 per cent have been for properties that have undergone some kind of renovation or addition.
Contacting a quantity surveyor to organise a depreciation schedule including a thorough site inspection can prevent missing out on unknown renovations.
A site inspection is especially important if your property was purchased second hand. The site inspector will make note of all plant and equipment assets in the property. Although some of these assets may be impacted by 2017 legislation changes, they can still be included in your capital loss schedule. In some scenarios this can be an important component if, or when, you decide to sell the property or dispose of the assets. More importantly though, a trained specialist will identify additional capital works that will qualify for capital works deductions via renovations or additions completed by previous owners, sometimes from many years prior to ownership.
Cosmetic versus substantial renovations
Cosmetic changes and substantial renovations are often claimed differently and can affect the extent that a future owner can claim depreciation. For more information see 2017 legislation changes.
Cosmetic changes are generally visual in nature or focus on a specific area of the property. Examples include work such as painting, sanding floors, removing and replacing fittings such as lights, replacing curtains or carpets. Cosmetic renovations only change the appearance of an asset not it’s structure.
Undertaking a cosmetic renovation is a good way to improve a property without incurring the expense of undertaking a substantial renovation, but it’s important to understand the differences and know what you can claim.
According to the ATO, the term substantial renovations is defined in legislative section 195-1 as:
“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.”
Renovations need to satisfy the following criteria to establish whether the renovations are substantial:
• The renovations need to affect the building as a whole; and
• The renovations need to result in the removal or replacement of all or a substantial amount of the building
Maximise the tax benefits with depreciation
Regardless of the type of renovation completed, whether it be an addition or laying new carpet, there are depreciation deductions available. BMT find clients an average of almost $10,000 annually in depreciation deductions.
To make the most out of renovations, it’s key to talk to a specialist quantity surveyor, even if you already have a depreciation schedule.
A BMT Tax Depreciation schedule outlines a forty-year forecast over the life of the property including the Division 43 and Division 40 components as a total yearly deduction. Both the diminishing value and prime cost method are shown for easy comparison.
To learn more about how renovations can increase tax deductions call BMT on 1300 728 726 or Request a Quote.