Depreciation: The four things you should know

Like many topics surrounding tax, depreciation discussions are interlaced with myth and truth. As properties get older, as do their contents, they depreciate in value.

While this doesn’t necessarily point to a drop in capital growth, it does match up well with wear and tear and age, and as such the ATO allows investors to claim a deduction on the building aspect, as well as the ‘plant and equipment’ within. A quick trick to determine plants and equipment is to imagine the property being picked up and shaken. If it falls off, then it is in this category.

Deductions equate to tax reductions for you, and can assist in reducing your holding costs legally.

However, there are four things you need to know about depreciation.

1. It is an ‘on paper’ cost, but this doesn’t mean you shouldn’t take the cost seriously
   
   When claiming the deduction from the ATO for tax depreciation, you’ll find that while they’re calling it a ‘cost’ – nothing came from your pocket. This ‘on paper’ cost may not have yet cost you, but don’t consider it free money. There’s a reason that the ATO provides funds for depreciation – and that’s because at some point you’re likely required to replace the plants and equipment and undertake repairs.
   
   Many property managers recommend that investors actually use the depreciation guideline to get an understanding of when they’ll likely need to re-carpet, or replace appliances. Get a hold on the ATO’s ‘life’ expectation for what is installed and prepare yourself to spend this money to get your property back into good condition.
   
   
2. You can claim depreciation benefits on things you throw out
   
   This is a little-known aspect of depreciation called ‘scrapping’. If renovating or altering a property, it’s likely you’ll throw some things out. If you decide to remove the carpet, or light fittings or any other aspect, keep records and provide them to a quantity surveyor. They should be able to add these into your depreciation schedule for a return from the tax office.
   
   Expect to receive a 100% deduction on the residual value of what has been thrown away.
   
   
3. Older properties likely still have depreciable items
   
   While knowledge around depreciation is growing, there are still some who do not think older properties can achieve a substantial depreciation benefit. This is not true.
   
   If you have not been claiming your tax deduction, you can get your previous returns adjusted. Many quantity surveyors will not charge you if the amount they manage to claim you back doesn’t cover their bill.
   
   If you have a property that has been renovated in some way, or extended, even if you were not the person to undertake these improvements then you will find there are extra depreciation benefits here too. You may not even realize that something has been updated within the property, such as hidden items e.g. plumbing, re-wiring or bathrooms that are dated but newer than the property itself.
   
   
4. There are two ways of calculating depreciation
   
   There are actually two ways to calculate depreciation. These are the following methods:
   
   Diminishing value
   
   Prime cost
   
   Investors can choose what suits them most. Diminishing value calculates the deduction as a percentage of the balance left to deduct, while the prime cost calculates a percentage of the cost for each year calculated.
   
   Essentially, diminishing value allows investors to access more in the first five to 10 years of ownership. If you are requiring more funds, or looking to sell in the short-term, then you might consider this method. However, prime cost provides a steady amount of depreciation year-in, year-out. This may suit those holding for longer or who prefer a fairly certain return each year.