The real estate industry is breathing a sigh of relief as the federal government has finally unveiled its plan to cut depreciation deductions on second-hand residential properties
On 14 July, after a long wait, the Treasury Office finally issued a draft bill detailing how depreciation deductions for second-hand plant and equipment will be treated moving forward.
Here are eight key takeaways from the draft legislation:
- If plant and equipment is included in a second-hand residential property that is purchased (ie contact exchange date) after 10 May 2017, the buyer will not be able to claim depreciation on those “previously used” assets. If you exchanged on a property prior to the budget announcement on Tuesday 9 May 2017, you are not affected by these changes at all.
- Buyers of brand-new property will still be able to claim depreciation on both the building and the plant and equipment.
- No change has been made to claims related to the structure of a property, known as capital works deductions or building allowance. This section accounts for an estimated 80–85% of a property’s construction cost.
- These changes do not apply if you purchase the assets in a corporate tax entity, super fund or a large trust (300-plus members). Unfortunately, self-managed super funds are treated the same way as PAYG earners and will be affected by the changes.
- If you contract a builder to construct a house and it’s an investment property from the outset, you can still claim depreciation on the plant and equipment.
- If a house is renovated while the owner is living in it, and then they decide to sell the house to an investor, it is assumed that the assets have been used and therefore depreciation cannot be claimed on those assets.
- When a property that is currently being used as an investment is renovated, depreciation can still be claimed on the new renovation.
- The most interesting part: while investors purchasing second-hand property can no longer claim depreciation on existing plant and equipment, they will have the benefit of paying less capital gains tax (CGT) when they sell the property. How does this work? In summary, what you would have been able to claim in depreciation under the previous legislation simply gets taken off the sale price in the event that you sell the property in the future.
Here is a simple example of how an investor can pay less CGT:
Sarah acquires an investment property in December 2017 for $700k and included within this property is $40k worth of second-hand depreciating assets. As the property has been used before, Sarah will not be able to claim depreciation on those assets.
In 2020, Sarah sells the building for $900k, which also still has $20k worth of those original depreciated assets included in the sales price. Sarah can now claim a capital loss of $20k ($40k less $20k) for the depreciation she was not able to claim during ownership.
Investors need to keep records of the dates they acquire and dispose of an asset, and of any amount that forms part of the cost base. And remember, if you purchase an investment property today that was built after 1987, you can still claim under the unclaimed building allowance component.
Tyron Hyde is the Director of Washington Brown Depreciation Specialists and is considered one of Australia’s leading experts in property tax depreciation.