An A-Z of depreciation
Depreciation can sometimes seem a bit confusing, particularly if it’s your first time hearing about it or you’re ordering a depreciation schedule for the first time.
To help you out, we’ve compiled this glossary of the main depreciation terms you are likely to come across.
Australian Taxation Office (ATO) – The ATO sets the tax rulings for depreciation. These rulings state what assets depreciation can be claimed for, the rate at which items assets depreciate, the qualifying dates of assets and their effective lives.
Capital Gains Tax (CGT) – The CGT is a tax that property investors may face when it comes time to sell their property one day. It is essentially the tax payable on the difference between what it cost you to purchase an asset (plus associated transaction costs) and the amount you received when you disposed of it (minus associated transaction costs). When you sell a property, this triggers what is called a ‘CGT event’ and the owner will either make a capital gain or loss on the property. Click here for more information on CGT and to learn what exemptions are available to property investors.
Capital improvement – A capital improvement occurs when the condition or value of an item is enhanced beyond its original state at the time of purchase, usually through a renovation or improvement. This must then be classified as either a capital works deduction and depreciated over time or as plant and equipment depreciation. It differs from a repair or maintenance – both of which can be claimed as a 100 per cent tax deduction in the year of the expense.
Capital works allowance – Capital works allowance or ‘building write-off’ is a deduction available for the structure of the building and the items within it that are deemed irremovable. Also referred to as ‘division 43’, capital works deductions can be claimed at a rate of 2.5 per cent over forty years.
Diminishing value – The ATO allows investors to choose between two methods of claiming depreciation on plant and equipment assets. The diminishing value method is one method of claiming depreciation (see ‘Prime cost method’ for the other option). Under this method, the deduction is calculated as a percentage of the balance you have left to deduct. If an investor makes their claim using the diminishing value method, they are claiming a greater proportion of the asset’s cost in the earlier years of the effective life of the asset as set by the ATO, therefore receiving greater deductions in the earlier years of owning the property.
Divisions 40 and 43 – Division 40 refers to the plant and equipment assets within a property while division 43 refers to capital works allowance or building write-off.
Estimate – Property investors can obtain an estimate of the likely depreciation deductions for their investment properties, free of charge from BMT. This can assist potential buyers in their pre-purchase budgeting and help them decide if a property is the right investment for them.
Immediate write-off – Assets that have an initial value of less than $300 are eligible for immediate write-off in the year they were purchased.
Low-value pool – Low-value pooling legislation allows owners to group qualifying depreciable assets in a pool which will depreciate at an accelerated rate. Property investors who acquire low cost assets and choose to place them in the low-value pool are able to claim them at a rate of 18.75 per cent in the year of purchase regardless of how long the property has been owned and rented. From the second year onwards the remaining balance of the item can be claimed at a rate of 37.5 per cent per year.
Low-cost assets – A low-cost asset is a depreciable asset that has an opening value of less than $1,000 in the year of acquisition.
Low-value assets – A low-value asset is a depreciable asset that has a written down value of less than $1,000. That is, the value of the asset is greater than $1,000 in the year of acquisition. However, the residual value after previous years’ depreciation is less than $1,000.
Maintenance – Maintenance is considered work completed to prevent deterioration to a property, for example oiling a deck. Deductions for maintenance can be claimed as an immediate write-off in the year an expense is incurred with the help of an Accountant.
PAYG withholding variation – A Pay As You Go (PAYG) withholding variation allows investors to take advantage of depreciation deductions throughout the year, instead of in one lump sum at the end of a financial year.
Partial year claim – The total depreciation available in the first financial year of owning a property is adjusted according to the portion of the year the property is owned. A depreciation schedule should include a partial year claim based on the time the property is rented.
Plant and equipment* –These are the removable assets found within an investment property. Examples of division 40 items that owners can claim depreciation deductions for include lights, blinds and ceiling fans. These assets depreciate according to an individual effective life and therefore depreciate at a much faster rate than structural items.
*Under proposed changes outlined in draft legislation (section 2 of Treasury Laws Amendment Bill 2017), investors who exchange contracts on a second hand residential property after 7:30pm on 9th May 2017 will no longer be able to claim depreciation on plant and equipment assets. Investors who purchased prior to this date and those who purchase a brand new property will still be able to claim depreciation as they were previously. Investors should note that these changes are not yet law, as the legislation still needs to be passed through the senate for confirmation. BMT Tax Depreciation remain in discussion with government around the new changes and will keep our clients informed on the outcome. To learn more visit www.bmtqs.com.au/budget-2017.
Prime cost method – The prime cost method of depreciation uses a lower percentage rate of depreciation and results in a consistent deduction each year, spreading out the deductions more evenly over time.
Repairs – Repairs are considered work completed to fix damage or deterioration to a property, for example, replacing part of a damaged fence. Deductions for repairs can be claimed as an immediate write-off in the year an expense is incurred with the help of an Accountant.
Qualifying date – As a general rule, any residential building where construction commenced after the 15th of September 1987 will entitle their owner to capital works deductions at a rate of 2.5 per cent per year for up to forty years. For commercial properties, the qualifying date for this capital works allowance is the 20th of July 1982.
Quantity Surveyor – Quantity Surveyors are one of a few professionals recognised by legislation (Tax Ruling 97/25) to have the appropriate construction costing skills to calculate building costs for capital allowance claims. Specialist Quantity Surveyors utilise a combination of construction cost expertise and knowledge of taxation legislation to concentrate on property depreciation.
Schedule – A BMT Tax Depreciation Schedule outlines all of the depreciation deductions in a property that an investor can claim.
Scrapping – Scrapping is the removal and disposal of any potentially depreciable assets from an investment property. In the year the item is scrapped, the full remaining written down value can be written off as a tax deduction.
Split report – Split reports are available when a property is owned by more than one person and can result in higher deductions earlier.