House depreciation: the phantom cash cow
Most people are still unaware that they could be sitting on a pile of money, thanks largely to the depreciating value of their house.
Mistakenly, many homeowners believe that it is their house that is going up in value but, in fact, it’s the land. That’s why the Australian Taxation Office (ATO) has made a provision for the depreciation of a dwelling, in the form of a depreciation schedule.
A tax depreciation schedule
Basically, a Tax Depreciation Schedule (TDS) lists all the various elements of a property and estimates how much wear is left. A dollar value is then given to the assessable property and an estimate is made of percentage of wear over the life of the property. You get a discount off your tax bill based on the wear percentage for that year.
It’s quite a complex process and requires a professional quantity surveyor. A surveyor will take a look at all of the components of the property and assess them, from bricks to mortar, to frames and windows. If would like to know how to find a quantity surveyor the Australian Institute of Quantity Surveyors is a good place to start. http://www.aiqs.com.au/Find_a_Member/index.htm
A quantity surveyor has extensive knowledge of construction as well as the deductions the ATO allows – it’s their job to make sure every claimable component is included in the depreciation schedule they prepare for you.
Depreciation: new for old, old to new
The ATO has determined that any new house, from the time construction is completed, is eligible to claim a 40-year depreciation at 2.5 percent. When purchasing older houses, the depreciation will be the balance. So if you purchase a house that is 10 years old, you can only claim depreciation on the property for the remaining 30 years.
There are two different ways to calculate depreciating value. The first is Diminishing Value (DV) and the other is the Prime Cost Method (PCM). For short-term investors the better option is generally Diminishing Value.
Depreciation calculated using DV allows investors to claim a greater proportion of the depreciation of the property in the early part of the effective life of the investment. This works well, when, for example, a property is bought as an investment, not a residence. It gives the investor more money upfront but only for a few years.
If, on the other hand, you are buying a property to live in and plan to keep it for many years to come you may prefer to apply the prime cost method of assessing depreciation. This method allows the owner to claim depreciation steadily over many years. You get a smaller sum back but over a longer period of time.
Income from an investment property
Many people make the mistake of thinking that depreciation can only be applied to new houses but this is not the case. A good quantity surveyor will find ways for owners to claim at least some depreciation even on older properties.
Under income tax law anyone is allowed to claim deductions for expenses incurred while earning an income that can be assessed. This includes rent.
For many property investors who have tenants paying rent, it is possible to claim depreciation for many parts of the house, including wear and tear of carpet, for instance.
The same can be said for renovations. Under the law, you may be able to claim depreciation for certain types of renovations, for instance, painting, additions or insulating. Interestingly, many people claim these as repairs and unfortunately the ATO may not agree with that categorisation.
Repairs and improvements are considered in two different categories by the tax office. Repairs are deductible, such as fixing broken windows or electrical appliances. It’s not possible to claim improvements as deductible items, so many people just don’t claim them at all. However, you can probably claim depreciation on improvements. If you have a depreciation schedule prepared usually the surveyor will allow one free revision if you do a renovation on the property within a set number of years. That way you will be able to claim the improvement costs on your schedule.