If you are an investor who is buying property for rental income with a strategy to hold the property for the long term you will want to depreciate your assets to the fullest extent possible. You can’t do this in every country, so you’ll want to consider countries where you can.
Australia is a good example of a county where high purchase and exit taxes (for foreign investors) mean it’s highly unlikely to appeal to investors looking to hold the property for the short term, but the ability to depreciate your assets means it’s attractive to long term investors.
This means that from an accounting perspective, you can deduct not only cash expenses but also non-cash expenses which will reduce your income tax liability.
Before we go further, please note we are not tax advisors or accountants. We are property experts and this information is intended as general information only. You should not rely on this information as tax guidance and you must seek advice from professional accountants or tax advisors if you are considering investing in Australia.
A non-cash expense is an accounting expense that does not involve the payment of cash. From a real estate investment perspective non-cash expenses are allowances investors can offset against their income to allow for the depreciation of their assets.
Non-cash expenses in Australia are defined as “deductions for the declining value of depreciating assets”. In Australia, if you purchase a new property, you are generally treated for tax purposes as having bought land, a building plus various items of ‘plant’. Items of the plant are depreciating assets such as air-conditioners, stoves, and other similar items.
Therefore, the purchase price of the property needs to be allocated between the building (capital improvements) and other depreciable items. Investors can then deduct an amount equal to the declining value of each asset from the income generated in the year which the asset was held, for each year of the useful life of that particular asset.
These are classified as:
- Capital improvements (the building)
- Plant; and
- Various other depreciating assets
Some items found in a rental property are regarded as part of the ‘setting’ (i.e. part of the building) for the rent-producing activity and are not treated as a separate asset in their own right. If a depreciating asset is not considered plant and it is fixed to or part of a building or a structural improvement, then it will generally be considered construction expenditure for capital works and only a capital works deduction may be available for that item.
Investors can depreciate the cost of a newly built residential property purchased from a developer, or residential property that has been substantially renovated if:
- No one was previously entitled to a deduction for the property, and
- The asset was installed for use or used at the property and you acquired it within six months of the property being built or substantially renovated
Substantial renovations of a building in which all, or substantially all, of a building is removed or replaced are generally considered capital improvements. The renovations may, but do not necessarily have to involve removing or replacing foundations, external walls into supporting walls, floors, roof, or staircase.
In Australia, residential rental properties are a setting for income-producing activities and so do not fall within the ordinary meaning of plant. Items that form part of the premises are also part of the setting, and therefore not eligible for deductions for the decline in value.
In determining whether an item is part of the premises or setting, the following needs to be considered:
- Whether the item appears visually to retain a separate identity
- the degree of permanence with which it is attached to the property
- the incompleteness of the structure without it
- the extent to which it was intended to be permanent or whether it was likely to be replaced within a relatively short period
None of these factors alone is determinative and they must all be considered together.
Wall and floor tiles are generally fixed to the premises, not freestanding, and intended to remain in place for a substantial period. They will generally form part of the premises. Expenditure on these items falls under capital works.
On the other hand, a freestanding item such as a bookcase may be attached to the structure only for temporary stability. It, therefore, does not form part of the premises and may qualify for a deduction for declining value.
Plant includes items that are articles within the ordinary meaning of the word. A curtain, a desk, and a bookcase will be considered articles.
In Australia, investors can deduct the decline in value of a depreciating asset using either the prime cost or diminishing value method. Both methods are based on the effective life of the asset.
Calculating the effective life
Generally, the effective life of a depreciating asset is how long it can be used to produce income:
- having regard to the wear and tear you reasonably expect from your expected circumstances of its use
- assuming that it will be maintained in reasonably good order and condition; and
- having regard to the period within which it is likely to be scrapped, sold for no more than scrap value, or abandoned
For most depreciating assets you can choose to work out the effective life yourself or to use an effective life determined by the Commissioner of taxation
Depreciation for the building
The depreciation claim for the plant, equipment, and buildings is often overlooked. You are normally allowed to claim a small percentage of the cost of the building and fixed structures on the property over time.
Usually, the rate is 2.5% from the time the property is built, the total claim is limited to the cost of construction and you need to get a quantity surveyor to do the figures for you.
Depreciation for furniture
If the property is furnished, the Australian tax office allows a landlord to claim the cost of the furnishings as a tax deduction throughout its useful life.
These may be for furnishings installed at the time of purchase or items bought during the rental period. Typically, an item of furniture can be claimed in the 5 to 10 years as stipulated by the tax office.
For a full list of rental property items that can be deprecated visit the Australian Taxation Office
In Australia, income tax rates are different for resident and non-resident investors, however, both have the ability to depreciate their assets. For more information on preparing your income statement, check out our article here.
The ability to depreciate your assets will impact the performance of your property. So whilst the cost of purchase may be high in some states in Australia, due to comparatively high foreign buyer stamp duty, the ability to depreciate your assets over time may outweigh this if your plan is to hold the property for long term income.
We know how hard it is to plan an investment strategy that’s right for you. It’s hard to compare properties in different countries on an after-tax basis, making it really difficult to make informed investment decisions. That’s why we’ve built our analysis tools to help investors compare the returns of properties (after tax) in different countries. We’ll be inviting Beta testers to trial our new platform shortly, so if you’d like to sign up email [email protected]
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