Based on years of experience in the property management game. With any luck what I have learned has been helpful, but to be perfectly honest, there are aspects of getting the most out of your investment where I am not an expert. I understand the concepts well enough, but there are other professionals out there who can teach it better than I can.
When investing in property, one of the most important cash flow considerations is tax. I am sure you feel like I do - I don't want to pay any less than my share, assuming that my tax dollars are going to make a better Australia for all of us, but I owe it to my investment to not pay any more than I have to.
Of course, everyone has their own idea of what is fair, which is why anything to do with the ATO seems so complicated. To get past the confusion, I've turned to Tass Assarapin at Mitchell Brandtman. Tass is a 5D Quantity Surveyor who's been with Mitchell Brandtman for seven years, and has worked on a range of residential, commercial and industrial projects up to $85M.
Paying taxes on your rental income can take a huge chunk out of your cash flow. One of the best ways to improve cash flow is to take advantage of the depreciation of your property. That means reducing your taxable income so you don’t need to pay as much tax. Just like you claim expenses (plumbing for example) you can claim depreciation on your property. This includes the building and the fittings inside like the carpets and blinds. This can reduce your taxable income by as much as $15,000 each year!
The biggest problem is that most people don't take advantage of what could be, for some, a hidden gem!
The reason is that it's not as simple as just telling your accountant to reduce the tax by claiming depreciation on your property. You actually need a Quantity Surveyor (that’s me) to physically visit your property and to write up the report to give to your accountant so they in turn can claim the depreciation for you.
A Depreciation Report will detail the depreciable assets in your property and provide a schedule of claimable expenses over the life of the asset, meaning you only need this one report to save thousands in cold hard cash year after year.
Get the sample I prepared for you at the bottom of this post.
You’ll see in this example the owner reduced their taxable income by $9,571 in the first year (using the diminishing value method). This could be the difference between going on the family holiday or getting closer to buying your next investment property.
I told Michael I would be happy to give you a discount on your depreciation schedule, which is the report you give to your accountant to claim the depreciation. I’ll give you the discount in a moment. But first, I’ll give you some more info so you understand how it works.
The ATO (Australian Tax Office) bases the 'Depreciation' or 'Write Down' of assets on the expense you incur as elements of your property gradually reduces in value or 'wears out'. This concept seems to fly in the face of the reason we invest in real property in the first place - property should not 'wear out', in fact, we expect it to continually increase in value.
Land does not wear out, but most of the things we put on it can. There are basically two types of depreciable assets in an investment property:
Building Structure- You’ll read this as ‘Capital Allowance’ in your depreciation schedule; and
Fixture and Fittings – known as ‘Plant and Equipment’
We treat these assets separately because they depreciate at different rates. Depending on when the structure was built, the depreciation rate is generally a predictable 2.5% over 40 years. The depreciation of Plant and Equipment assets (such as carpet, blinds and air-conditioning equipment) have shorter ‘effective lifespans’.
- Blinds EL = 10 years Dep Rate is 100/10 = 10%
- Curtains EL = 6 years Dep Rate is 100/6 = 16.67%
- Carpet/Vinyl EL = 10 years Dep Rate is 100/10 = 10%
- Hot water unit EL = 12 years Dep Rate is 100/12 = 8.33%
Keeping with this example above, this means you can claim 10% of the value of the blinds for 10 years. So if your blinds were initially valued at $5,000, you could reduce your taxable income by $500 in the first year alone. Thats just depreciation on the blinds, imagine how much more you could save.
Methods of Depreciation
There are two main ways that you can claim depreciation, the Prime Cost and Diminishing Value methods.
Prime Cost- generally the same amount of depreciation is claimed year after year.
Diminishing Value- more depreciation is claimed in the first few years, then gradually less year after year.
Here’s an example:
You can see in the example above the owner of this property reduced their taxable income by $11,613 in 2014, $10,803 in 2015 and $9,190 in 2016. Notice how the depreciation of the fittings and the building reduced over the 3 years.
Most people use this method (including myself) as it tends to be more ‘front loaded’ than the Prime Cost method. Compare years 2-6 between the 2 methods in the sample I have linked below. Everyone wants a bit more, sooner. Even though overall, the same amount is taken off your tax income.
Notice in the below Prime Cost method the values are lower in the first 3 years:
* All above figures are based on a 4 bedroom, 2 bathroom newly built house with standard project home builder inclusions. This is to be used as a guide only.
Tax Depreciation Benefits
Although claiming asset depreciation requires a Tax Depreciation Report that has to be prepared by a Quantity Surveyor (and Registered Tax Agent), as an investor you will likely find it worthwhile. As a taxpayer, you will find that claiming Tax Depreciation will:
- Reduce YOUR tax assessable income, which, in turn,
- Reduces YOUR tax payable, so it follows that it
- Increases YOUR cash flow, which
- Helps YOU achieve positive cash flow, helping to
- Enable YOU to purchase YOUR next property sooner!
I did promise at the start I would give you a special rate for being a Cubbi reader.
The DISCOUNTED fee for a tax depreciation schedule for a residential property will cost you $440 including GST (for most metropolitan areas). This fee is TAX DEDUCTIBLE and generally, the first year of savings will cover the fee paid to us anyway! Got more questions? Give me a call on 1800 454 434 and ask to speak to Tass.