By Tyron Hyde
Almost anyone who has anything to do with property has at least heard of the changes made to depreciation rules in the Federal Budget handed down in May this year. But while most people are aware of the new legislation, not everyone completely understands it and its implications. And no wonder, since it’s quite complex.
Nevertheless the changes are here and they’re here to stay – at least for now – so it’s important to have a good grasp on them. They won’t affect anyone who already owned and rented out a residential investment property prior to the budget, at least not in terms of what they can claim in depreciation deductions; saleability may be a different story. The new rules will, however, impact anyone buying a residential property after the budget was handed down, particularly with a view of having it as an investment, at least at some point. Why? Because the allowable tax deductions for depreciation on second hand residential properties purchased after the budget have reduced.
The major changes
Depreciation is the loss in value of an asset over time due to wear and tear. It is an allowable tax deduction for property investors and often a very lucrative one.There are two types of depreciation – capital or building allowances which apply to the structure, and plant and equipment, relating to removable items such as window coverings and whitegoods. Until now both could be claimed as a deduction for any type of property but the new legislation has changed the rules for residential property. While capital allowances remain untouched, plant and equipment can only be claimed as a deduction for brand new properties, with second hand properties now excluded.
The key takeaways from the new legislation are:
• While existing investment properties are grandfathered – ie. owners will still be able to claim depreciation in the same way as before – second hand properties bought after the budget will no longer be eligible for depreciation deductions on plant and equipment as they are now deemed to be ‘previously used’. But investors buying these will be able to pay less capital gains tax (CGT) when they sell, as the depreciation now unable to be claimed can constitute a capital loss.
• Brand new properties will be able to claim depreciation deductions for both capital allowances and plant and equipment.
• Building allowances are untouched for all property, as the depreciation restrictions for second hand properties only applies to plant and equipment.
• The changes only affect residential properties, with commercial properties and all other non-residential properties unscathed.
• If you buy a property in a corporate tax entity, super fund (not SMSF) or large unit trust you can still claim depreciation for both.
• If you acquire a second hand property and renovate it yourself with brand new items you can still claim depreciation just as you did before, as you’ve incurred the expense yourself, rather than a previous owner.
• While the depreciation laws are grandfathered, it will only apply if the property was income producing in the 2016/17 financial year. So, if you bought the property five years ago and turn it into an investment property in the 2017/18 financial year, you won’t be ale to claim depreciation on the previously used plant and equipment items even though you exchanged prior to the Federal Budget. You will still be entitled to claim the building allowance, however, provided the structure was built after 1987.
What does it mean for property?
Gazing into my crystal ball, I can see changes ahead for the property market resulting from the new depreciation legislation:
• Near-new properties will be hard to sell. People trying to sell properties around two to five years old will struggle as they won’t be as attractive to investors as brand new ones. This will especially be the case in multi-staged developments, where brand new homes are built next to those that are a few years old – the difference in depreciation could be $20,000 compared to $4,000 in the first year alone. Properties built eight to 12 years ago will be a little more attractive as the renovation potential is there.
• Developers will rejoice
They’ll be dancing in the street because the new rules make their stock more attractive compared to near-new and older property, effectively creating a two-tiered property market. I suspect they will even change their advertising to reflect the fact that depreciation can still be claimed for these properties and not others. “Buy brand new,” they’ll say. “We’ve got the shiny ones that are now even shinier with greater tax breaks!”
• Purchasing in company names will become more prevalent
Since buying in a corporate tax entity means you’re not affected by the changes, more people will start to buy company names. This way they’ll still benefit by being able to claim depreciation for plant and equipment as before. They’ll also have the added advantage of being able to continue claiming travel allowances, as this other change to investment property in the Federal Budget also exempted those purchased in a corporate tax entity.
• Confusion will abound
Some people, particularly property investors, will be scratching their heads when they work out what the changes actually mean. The confusion will peak when it comes time to calculate the CGT implications of the investment when they sell it. It’s very confusing, particularly for mixed-use properties that have a part-residential, part-commercial holding on the one title with different tax structures, such as a retail strip with shops at the bottom and apartments on top.
Tyron Hyde is the CEO of quantity surveying firm Washington Brown. Washington Brown are experts in the preparation of depreciation schedules for property investors. Tyron is also the author of CLAIM IT! Australia’s only published book on the topic of property depreciation. For more information visit https://www.washingtonbrown.com.au/?gclid=EAIaIQobChMI8bK6yYnl1wIVxiMrCh0bewQQEAAYASAAEgKNPfD_BwE