A smart property investment strategy is not just about capital growth and high rental yields; it’s also about improving cash flow. Tyron Hyde, from Washington Brown Quantity Surveyors, outlines his top depreciation tips for maximising cash flow
Claiming depreciation on your property is one of the most important steps in any successful investor’s journey. It’s the only deduction that can be subjective. All other expenses, including interest, strata fees, etc., must equal the precise amount paid out. Here are my top tax depreciation tips for property investors:
1. Maximise the cost of construction
When calculating the depreciation on an investment property, the original construction cost must be used. Due to the current economic climate, many of our clients are now buying properties at dramatically reduced prices, nearer to the original building cost. So the tip is to make the most of the current market conditions and search for properties where the actual construction cost is close to the current purchase price.
By way of example, we had a client that recently bought a property in Cairns for $120,000. It was a 12-year-old, two-bedroom unit. Guess what? We still used the original construction cost, which came in at close to $100,000, as the basis for the incoming property investor. Not only has the new purchaser therefore paid less stamp duty and increased their chance of a capital gain, but their depreciation deduction relative to the purchase price has also increased. And this property will be cash flow positive; or cash flow neutral in the worst-case scenario.
2. Don’t assume that you can’t get depreciation benefit because of the age of your property
Even properties built before 1985 (when the building allowance kicked in) are worth depreciating. The purchase price of your property includes the land, building and plant and equipment. As a quantity surveyor, part of our role is to apportion or break down those categories for you. In roughly 99% of cases, we find enough plant and equipment items to more than justify the tax-deductible expenses of engaging our firm.
3. When it comes to depreciation, the taller the building, the more you can claim
Taller buildings attract higher plant and equipment allowances. The higher the plant and equipment, the higher the depreciation. ‘Plant and equipment’ refers to necessary services within the building, as well as items within the property itself. Some of the services required as buildings increase in height are obvious, such as a lift (transportation service). Other services are less obvious, with fire-hose reels and intercoms all being depreciable under this category.
The other reason tall buildings have a higher ratio of plant and equipment has to do with the amenities the developer provides. For instance, some high-rise buildings have swimming pools, gyms and even mini cinemas.
Let’s look at the numbers. The first thing to do is to look at a rough ratio of plant and equipment relative to construction cost, then take a look at how how this translates into deductions (see ‘Tip 23’ table). These allowances all relate to a $400,000 property in a capital city, and are very approximate for illustrative purposes only. As you can see, the taller the building, the more you can depreciate. But keep in mind that a tall building doesn’t necessarily make a better investment. It often means there’ll be higher levies and additional expenses, and you own less land as well. But at the end of the day, it’s up to you to weigh the pros and cons and make that final decision!
4. Claim small items and low-value pooling immediately
A dollar today is worth more than a dollar tomorrow, so deduct items as quickly as possible. Individual items under $300 can be written off immediately.
An important thing to remember here is that provided your portion is under $300 you can write it off. For instance, say an electric motor for the garage door cost an apartment block $2,000. If there were 50 units in the block, your portion would be $40. You can claim that $40 outright, as your portion is under $300. You can also try to buy items that depreciate faster. Items between $300 and $1,000 fall into the ‘low pool’ category and attract a higher depreciation rate. For instance, a $1,200 television attracts a 20% deduction, while a $950 television deducts at 37.5% per annum.
5. Use an experienced quantity surveyor
For starters, let’s put this issue in perspective. You have just paid hundreds of thousands of dollars for a property – do you really want to save a couple of hundred tax-deductible dollars on the only tax break available to you that can be open to interpretation and skill? The ATO has identified quantity surveyors as appropriately qualified to estimate the original construction costs in cases where that figure is unknown. I suggest you engage a firm that has been around for at least 10 years. They will have the necessary experience to analyse your property correctly. The laws have also changed frequently over the years and each building is unique, so it pays to get expert advice. The ATO requires all companies who prepare tax depreciation schedules to be registered tax agents.
6. Avoid properties with a 4% building allowance
Residential properties built between 18 July 1985 and 15 September 1987 attract a 4% building depreciation rate over 25 years. Everything built since then attracts a 2.5% rate over 40 years. Therefore, if you buy a property that commenced construction during the 1985 to 1987 period, you can claim on the building allowance until 15 September 2012. However, if you buy a property that commenced construction in 1992, for example, you still have 20 years in which to depreciate the property, at 2.5%. That’s 50% of the original construction still left to claim!
7. Furnish your property
Furnishing your property is another way to increase your depreciation deductions as it attracts higher depreciation rates. For example, a $20,000 furniture package supplied by a developer can result in an additional $10,000 deduction in the first year alone. But remember, furnishing your investment isn’t necessarily the best option for all properties and locations. It’s better suited to smaller one- or two-bedroom apartments in transient areas that attract short-term tenants and holiday rentals.
8. Claim the residual value write-off
I believe millions of dollars will be missed over the coming years in tax depreciation claims due to changes in what can be defined as ‘plant and equipment’. When I first started preparing depreciation reports, there were several factors that determined what made the list. These included whether the item was absolutely necessary in order to make the property available to be rented out. For instance, a kitchen was an absolute necessity but a microwave was not. So if you are renovating a kitchen or bathroom on a property built after 1985, get a quantity surveyor in before you demolish so that they can assess what the residual value of these items is. That value can still be claimed as an outright deduction and can generate huge savings in the first year. For instance, a rental property with a 20-year-old $10,000 kitchen attracts an immediate deduction of around $5,000.
9. Don’t bother with DIY depreciation
As an expert in the market, I am baffaled at the number of companies offering a ‘do-it-yourself’ option. I personally think there are some legal anomalies here, but, more importantly, I think you will be missing out on major deductions.
Here’s one example. The DIY options in the marketplace give you a tick sheet and ask you to take your own measurements. Now let’s say you measure from one bedroom wall to the other. If you do that all around the house, you will reduce the property by 10% in gross area. Merely measuring off inside surfaces fails to include the surface area occupied by all internal and external walls. At approximately $1,500 per square metre to build, you will miss out on something like $15,000 worth of tax deductions!
10. Calculate estimated depreciation deduction when comparing properties
If you’re considering buying a five-year-old property but are concerned that the depreciation deductions won’t be as high as a brand-new property, you can now compare the two using online depreciation calculators such as the one hosted on our website. It’s a free calculator that allows you to compare apples with apples and uses real-life data collated from every inspection we do on behalf of our clients.