An individual’s strategy is just as important a factor to consider when claiming the deductions available from an investment property as it is to obtain a comprehensive depreciation schedule outlining all of the depreciation that can be claimed.
While many investors fail to maximise depreciation deductions for their investment property, those who do obtain a schedule aren’t always aware that they can choose between two different methods when claiming depreciation for the plant and equipment assets found within the property.
A specialist Quantity Surveyor will use two methods to outline the deductions that can be claimed in a depreciation schedule as explained below.
Prime cost method
Under this method, the depreciation deduction for each year is calculated as a percentage of the cost. A simple way to explain the outcome of this method is that deductions will occur in a relatively straight line. Basically, this means an investor will receive more constant deductions throughout the life of the property.
Diminishing value method
Under the diminishing value method, the deduction is calculated as a percentage of the balance you have left to deduct. By selecting this method, an investor’s deductions for plant and equipment assets will be higher in the earlier years of owning the property and depreciate over time.
The following comparison graph shows an example of the deductions for assets over the first ten years using both of two methods.
When an investor first contacts a Quantity Surveyor to ask for a depreciation schedule, it is important to ask whether a schedule will incorporate both methods in the final report received.
Once the schedule has been prepared and received, the next step an investor should take is to seek advice from an Accountant or a tax professional on which method will suit their individual investment strategy.
This step is important as a property investor can only choose one method to claim depreciation deductions for assets. Once they have made their selection, they may not be able to change their method for the assets which they have claimed deductions for in previous years.
A simple guide to help investors choose between the two methods is to explain that those who only plan on holding a property for a relatively short period of time, those wish to build their investment portfolio quickly or those who might want to save to budget for a renovation may prefer the diminishing value method.
Alternatively, those who might prefer to claim deductions so they receive them at a more constant rate over a longer period of time may choose the prime cost method of depreciation.
When obtaining a depreciation schedule for any investment property purchase, it is important to ask questions to understand the difference that depreciation deductions will have on your individual scenario.
Depreciation deductions can have a significant impact on your cash flow, both immediately and in the future. It is therefore important to think about how any additional money received can be incorporated into your budget as this will help you to achieve your investment strategy and ensure that the decision to purchase a property is the most prosperous one.