There are two variables that would be accounted for in a survey when it comes to claiming depreciation on your rental property. There is Divisions 40 (Plant and Equipment) and division 43 (Capital Works).
Division 40 – Plant and equipment
Division 40 is the category which covers assets that are easily removable from a building rather than attached or fixed. These include appliances and furnishings. Each item of plant or equipment within your property has an effective life measured in number of years.
Each item has an effective life that is measured in years which is set out by the ATO. This can be found within the document ‘Taxation Ruling TR 2019/5 – Income tax: effective life of depreciation assets’.
You may depreciate the division 40 assets via the diminishing value or the prime cost method. While the end value is the same, when the items depreciate at a rapid rate within the first few years, most people choose the diminishing value method for depreciation.
A fridge, for instance, has an effective life of 12 years. It depreciates at a rate of 16.6% of its present value per annum until it meets less than $1,000 in value. The depreciation rate increases to 37.5 % (as per low-value pooling) if the value is less than $1,000.
Plant and equipment fall under the Division 40 asset class and are depreciated as per the following methods:
A low-value asset is an asset that has depreciated over one or more years and now has a written-down value of less than $1,000, but only if you used the diminishing value method to work out deductions for it previously. You calculate the depreciation of all the assets in the low-value pool at the annual rate of 37.5%.
If you purchase an asset during an income year and allocate it to the pool, you calculate the deduction in that first year at a rate of 18.75% (that is, half the pool rate). This rate applies regardless of at what point you add the asset to the pool within the year.
Eligible plant and equipment items with a cost of $300 or less qualify for an immediate full deduction.
In comparison to the low-value pool, capital works items depreciate over a 40-year period at 2.5% per annum. For example, if you repaint the house for $10,000, the value of this figure will be equally depreciated for a period of 40 years, equal to $250 per annum. There is therefore a significant distinction between these two depreciation elements.
This is the depreciation of an asset worth $10,000 with an effective life of 5 years, as illustrated above. It is very important because as you can see, in the first few financial years, using the diminishing value method yields more tax deductions.
For example, a fridge, oven, rangehood, ventilation fan, air conditioning unit, and blinds all fall under the Division 40 asset class.
With the ruling from the Federal Budget of 2017, we have witnessed several changes:
Income tax deductions for the decline in value of previously used plant and equipment in rental premises used for residential accommodation are no longer allowed. The changes are now law.
The changes apply from 1 July 2017 to:
- previously used plant and equipment acquired on 9 May 2017 at or after 7:30pm unless purchased under a contract entered into before this time.
- plant and equipment acquired before 1 July 2017 but not used to earn income in either the current or previous year.
- these adjustments are only applicable to investors in residential property and purchased under an individual or self-managed superannuation.
Investors purchasing new buildings and equipment will continue to be entitled to claim a deduction over the effective life of the asset. In addition, all ‘substantial renovations’ to the building will be treated as new premises and will be able to claim both aspects of depreciation.
This ruling does not affect Division 43 – Capital works or any properties that are non-residential.
Division 43 – Capital Works Deductions
Division 43 – Capital works refer to the depreciation of the structure of the building, usually objects that are removable.
Capital works include:
- Alterations or improvements to a leased building
- Structural improvements
- Buildings or extensions
- Alterations or improvements to a building
- Earthworks for environmental protection
Capital works may also be known as Building Write-Off or Capital Works Allowance.
Residential properties constructed after September 15, 1987 are eligible for division 43 capital works deductions throughout a 40-year period that would be depreciated at 2.5% per annum as a straight line. A qualified specialist, such as a Quantity Surveyor, would be responsible for estimating the building where construction costs are uncertain.
For example, tiling, walls, driveways, fencing, garage, paint, roofing all fall under the Division 43 capital works class.
While division 43 capital works is strictly for residential property deductions, you are also allowed to claim depreciation on other buildings used for other purposes. Buildings used for office, storage or residential purposes are such examples. The specific deduction rates differ between buildings and can be discovered via the ATO.
Additionally, preliminary expenses such as surveying and engineering feeds are also factored in a capital works schedule.
At Duo Tax Quantity Surveyors, we recognise the importance of correctly differentiating the items into its rightful category to ensure you are entitled to the maximum tax deductions.
By Tuan Duong
Tuan is the Principal and Founder of Duo Tax Quantity Surveyors. His passion is to educate property investors in the power of tax depreciation and the benefits it can offer in helping them minimise their tax liability. Tuan is also a professional member of the Australian Institute of Quantity Surveyors and is a Registered Tax Agent, authorised to offer advice on all matters related to depreciation.