One of the tax benefits of owning an investment property is the ability to write off (or depreciate) the cost of capital assets included within the property as a deduction from your overall income from the property.
However, changes a couple of years ago have adversely affected the tax benefits available to property investors in relation to depreciation.
So, first things first; what is depreciation? Well, depreciation is a generic accounting term used to describe how an asset declines in value over time.
Depreciation of assets within an investment property are based on the ‘useful life’ of the asset, or the number of years the asset is expected to be in use. There are two ways of working out the useful life of an asset. First of all, the ATO annually produces tables of indicative useful lives for a comprehensive list of assets, including almost everything you can imagine being found within an investment property. The current one is TR 2018/4 (https://www.ato.gov.au/law/view/document?DocID=TXR/TR20184/NAT/ATO/00001). Alternatively, if you disagree with the ATO’s view, you can self-assess the useful life of an asset, provided you can substantiate your view to the ATO.
Amongst the assets that can be depreciated are items such as:
- clothes dryers
- blinds and curtains
- air conditioners
- hot water systems
In the case of depreciating assets, depreciation is based on the acquisition cost of the item, which may vary in value depending on the type of asset. Carpet, for example, can vary in price and quality, and this will be reflected in the depreciation allowance.
Where things become more complex is that new restrictions on the depreciation of second hand assets were introduced in relation to property investors with effect from 9th May 2017. Essentially, unless you are carrying on a business of property investing (which excludes the vast majority of taxpayers with a small portfolio of properties) or are an excluded entity (such as a company), you cannot claim for depreciation of second-hand plant and equipment in rental premises used for residential accommodation.
These changes apply to second-hand plant and equipment acquired at or after 7.30 pm (AEST) on 9 May 2017 unless you acquired them under a contract entered into before this time.
Additionally, you cannot claim for plant and equipment installed on or after 1 July 2017 if you have ever used it for a private purpose.
The following table sets out when depreciation deductions can be claimed for assets in residential investment properties:
|Date of purchase||New assets||Second-hand or used assets|
|Property purchased for rental purposes before 7.30pm on 9 May 2017||Yes||Yes|
|Depreciating assets in a brand new or substantially renovated rental property purchased at or after 7.30pm on 9 May 2017||Yes||No|
|Depreciating assets in an existing rental property purchased at or after 7.30pm on 9 May 2017||Yes||No|
|Depreciating asset purchased before 7.30pm on 9 May 2017||Yes||Yes|
|Depreciating asset was purchased at or after 7.30pm on 9 May 2017||Yes||No|
Off the Plan Developments
Under the new rules, developers who build a new residential property will have a six month period to rent out the property and still be able to sell the property to an investor with full depreciation entitlements.
This is to prevent an unfair outcome where a developer builds a new property then rents it out for a short period whilst a buyer is sought. In the absence of this exemption, the buyer of the property – who might reasonably believe they are buying a new home – would actually be blocked from claiming depreciation because the ATO would regard the assets as second hand.
Where a developer decides to do this, assets will be considered trading stock and no depreciation can be claimed by the developer while they are renting the property
The best way to illustrate the way the new rules work is by way of an example.
Let’s say that Bruce purchased a three year old residential apartment under a contract dated 1 June 2017 which settled on 1 August 2017. Bruce rented the property from 15 August 2017. The apartment contained a number of depreciating assets including carpet, blinds and an air conditioning unit.
Before renting the property, Bruce also installed a number of additional depreciating assets including
- Curtains purchased new from ‘Curtains ‘R’ Us’
- A second hand washing machine he found and purchased on ‘Gumtree’
- A fridge that he previously used for his personal use in his home
Bruce cannot claim depreciation for the pre-existing and therefore previously used assets, including the carpet, blinds and air conditioning unit. He also cannot claim a deduction for the washing machine (which was second hand) and the fridge (which he’d previously used personally).
He can claim a depreciation deduction for the curtains which were new.
The availability or otherwise of depreciation deductions for second hand assets, in either new or second hand properties, is a source of confusion for many taxpayers so make sure you talk to your tax agent to understand what you’re entitled to claim and what you’re not entitled to claim. With the ATO targeting excessive or incorrect deductions for rental properties, it certainly pays to double-check that your claims are correct.