Invest with Confidence: A Step-by-Step Guide to understanding property depreciation.

Discover the true potential of a depreciation schedule and understand how it is a powerful tool that helps property investors maximise their tax benefits.  Understand its ability to unlock deductions on your tax returns and revolutionise your property investment journey.

Understanding depreciation is a vital aspect for any property investor.  By leveraging depreciation on your investment property, you can effectively maximise your tax savings.  If you’re considering investing in Australian property, it’s crucial to grasp the significance of depreciation and how it can work to your full advantage.

Depreciation is a financial accounting method used to allocate the cost of tangible assets over their useful lives.  In the context of real estate investment, it refers to the gradual decrease in the value of a property over time due to wear and tear, obsolescence, and aging.  Depreciation is not an actual cash expense, but it is a valuable tool for property investors to recognise the reduction in the property’s value for tax purposes.  Property depreciation refers to a tax deduction that encompasses the capital works expenditure on a property, as well as the reduction in value of its content over time.

Why You Should Have a Depreciation Schedule for an Investment property.

Creating and maintaining a depreciation schedule for your investment property offers numerous advantages, making it a crucial aspect of your financial strategy.  Investment properties are acquired with the primary goal of generating income, often through rental income and potential appreciation in value.  As a result, they are typically categorised as taxable assets.

By taking advantage of tax deductions linked to depreciation, which factor in the gradual deterioration of the property over time, you can potentially offset your taxable income from the investment property and thereby reduce the amount of tax you pay.

Below are the key reasons why you should have a property depreciation schedule:

Tax Savings: One of the most significant benefits of depreciation is the potential tax savings it offers.  The depreciation expense is considered a non-cash deduction, meaning you can deduct it from your taxable income without having to spend any money.  As a result, your overall tax liability reduces, leading to higher cash flow and more funds available for reinvestment in the future.

Increased Cash Flow: By lowering your taxable income through depreciation, you effectively increase your property’s after-tax cash flow.  This additional cash flow can be reinvested into the property or used for other investment opportunities.

Improved ROI (Return on Investment): Depreciation enhances your property’s ROI by boosting your net income.  A higher ROI makes your investment more attractive, especially when compared to non-depreciating assets with similar returns.

Asset Value Recognition: Depreciation helps to recognise the natural decline in the value of the property over time.  Including depreciation in your financial statements provides a more accurate representation of the property’s true worth, which is crucial for investors, lenders, and potential buyers.

Asset Replacement Planning: Knowing the estimated lifespan of various components of the property helps you plan for future repairs and replacements.  This enables you to budget for these expenses and avoid sudden financial burdens.

Tax Deferral Benefits: Depreciation can lead to significant tax deferral benefits.  As your taxable income decreases due to depreciation deductions, you may find yourself in a lower tax bracket, resulting in deferred taxes until the property is sold.

Cost Recovery: Real estate properties, like any other asset, experience wear and tear.  Depreciation allows you to recover some of the original cost, which is particularly helpful if you plan to sell the property in the future.

Fair Property Valuation: A depreciation schedule can be beneficial when determining the fair value of the property for insurance purposes or when conducting financial audits.

Compliance with Tax Regulations: A depreciation schedule ensures that you comply with tax laws and regulations related to the deduction of depreciation expenses.

Wealth Building: Through tax savings and increased cash flow, depreciation assists in wealth accumulation, allowing you to build a more extensive and diverse property investment portfolio.

Can depreciation be claimed on older investment properties?

Capital works deductions can be claimed on investment properties constructed after the 17th of July 1985.  If you are unsure about the precise construction expenses, you have the option to obtain and estimate from a quantity surveyor or another qualified independent professional.  Typically, the deduction is spread over a period of 25 or 40 years.

Starting from the 1st of July 2017, it is important to note that you can only claim depreciation on new plant items that you have bought for your residential investment property, and not on second-hand items.

How does depreciation work for brand new investment properties?

For a brand-new property, it’s possible to be eligible for tax deductions on both capital works and depreciating assets (such as plant items).

The amount you can claim as a tax deduction is influenced by various factors, such as the property’s size and the presence of common areas like lifts and lobby areas, which may also qualify for deductions.  It is crucial to seek professional assistance for an accurate calculation.

How can I arrange a depreciation schedule for an investment property?

Utilising an online depreciation calculator can provide a rough estimation; however, due to the technical and intricate nature of the process, seeking professional assistance is highly recommended.

Initially, it is essential to engage an accredited professional to conduct an inspection and prepare a property depreciation schedule based on the assets’ age and other relevant factors.  This approach ensures a precise estimate and guarantees that no eligible assets for claiming are overlooked.

To ensure accuracy, it is crucial to employ a surveyor accredited by the Australian Institute of Quantity Surveyors.  While surveyor fees may vary, it’s essential to weigh this cost against the potential tax deductions that might be claimed.  Moreover, it’s worth noting that quantity surveyor fees are typically tax deductible.

After obtaining the depreciation schedule, you can simply share it with your accountant, who will incorporate it into your tax returns when filing at the conclusion of the financial year.

Remember that keeping records of both income and expenses, including the property’s depreciation schedule, is imperative for your investment property.

How is property investment depreciation calculated?

The capital works depreciation deduction is calculated as 2.5 % of the total construction costs annually over a span of 40 years.

Depreciation for plant items is determined by the asset’s effective life, which signifies its income-generating duration.  You can either calculate the effective life yourself or utilize the one prescribed by the ATO.

The ATO offers two depreciation calculation methods: the prime cost (straight line) method and the diminishing value method.  In the prime cost method, you claim a fixed percentage of the asset’s value throughout its effective life.  On the other hand, the diminishing value method assumes a constant proportionate decline in value each year, resulting in a progressively smaller decrease over time.

Low-cost items valued at less than $300 are usually eligible for immediate deductions.

When should I arrange a property depreciation schedule?

It is advisable to arrange a tax depreciation schedule shortly after your property settlement.  This schedule remains valid indefinitely but should be revised whenever there are property renovations, repairs, or asset placements.  Property owners typically prefer to have rental properties inspected before tenants move in.

However, if you failed to correctly address this in your previous income tax return, you usually have up to 2 years from the ATO’s notice of assessment issue for the relevant year to amend the tax return.  If you wish to proceed, it is essential to consult your tax adviser.

Now that you understand the basics of property, depreciation, feel free to make contact with our team to find out how you can start your own investment portfolio.

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