It’s no secret that there are different strategies when it comes to investing in property. Some people prefer to invest in brand-new properties, while others opt for older property that they can renovate and resell for profit. Whilst depreciation should never be the reason behind an investment decision, recent legislative changes have altered which types of properties are eligible for depreciation deductions.
When announcing the Legislative Changes in 2017, the government stated that moving forward, they will “Deny income tax deductions for the decline in value of ‘previously used’ depreciating assets.”
What does this mean for investors? Let’s look at this in context. If you look at the table below, you’ll see a simplified net effect of the cost of owning an investment property broken down into three generalised scenarios:
- A brand-new property;
- A second-hand property built between 1987 and 2018; and
- A property built before 1987.
1987 – 2018
@ $700 Per Week
|Interest @ 4% of
@ 1.5% (Rates, levies)
|Cash Surplus/Outlay Before
|Year 1 Depreciation Deduction – Building||-$4,000||-$4,000||$0|
|Year 1 Depreciation
Deduction – Plant & Equipment
|Total Taxation Position||-$13,850||-$2,850||$1,150|
|Tax Refund @ 37%||$5,125||$1,055||-$426|
(Net Outlay + Tax Refund)
|Cash income Per Week
(If a Positive Number, the Property is paying you)
The assumptions are the same for each scenario: each property will generate a weekly rental income of $700 over a 52-week period, which works out at $36,400 per property.
Furthermore, the interest rate is 4 per cent for each property. Each scenario incorporates an LVR of 80 per cent of the purchase price ($750,000) – This equates to an annual interest expense of $24,000.
Each property will have other expenses – Assumed at 1.5 per cent of the purchase price, which is $11,250 annually. Granted, you could argue that property built before 1987 could have higher expenses, but for ease of comparison, we’ve kept the same rate.
So, it’s the same scenario for each property with the net outlay before depreciation of $1,150.
Now, here’s where things get interesting! What about the depreciation?
- In a brand-new property, the total depreciation deduction in year one is $15,000 (Building Allowance + Plant & Equipment).
- For the second-hand property built between 1987 and 2018, the total depreciation deduction is $4,000. This is due to the fact that the property is not brand new and the Plant and Equipment component is seen as previously used and cannot be claimed on. The only deduction available here are against the original structure and the structural component of any previous owners’ improvements/renovations.
- For a property built before 1987, the depreciation is $0. It is important to note here that, if the property has had improvements/renovations done by a previous owner, you are eligible to claim on the structural component of this. As accredited Quantity Surveyors, it is our job to estimate the date and costs of these previous works.
Note: Recipients of this email are entitled to a FREE estimate of the depreciation deductions available. If you own an investment property, new or second-hand, and haven’t had a depreciation schedule prepared, click here to request an estimate.
Depreciation on a brand-new property
You can see that the total tax loss on the brand-new property is quite high at $13,850. If you are an investor who is paying tax at a marginal tax rate of 37 per cent and you’re making a loss of $13,850, you will receive a tax cheque back from the ATO to the tune of $5,125 – and that’s cash in hand.
This amount, plus the $1,150 (Cash Surplus Before Depreciation) is $6,275. In this example, the property has been paying you $6,275 a year to own that property – so the net return is $120 a week positive cash flow.
Depreciation on an old property
Next, let’s look at the property built before 1987. Again, there is a $1,150 cash surplus before depreciation. In this example, you cannot claim depreciation on the previously used Plant and Equipment or on the original structure. So, here, you’ve actually increased your taxable income by $1,150. If you are in the 37 per cent income tax bracket, this equates to you paying an additional $426 in tax.
Given that you’ve made $1,150 and have then paid the additional $426 in tax for this, you are roughly $724 up per year. That’s around $14 per week you are making to own a property built before 1987.
Depreciation on a second-hand property built between 1987 and 2017
Using the same variables, if you bought a second-hand property built between 1987 and 2018, your annual tax loss would be $2,850, so you would receive a tax refund of $1,055 (providing you are in the 37 per cent bracket). Your cash surplus before depreciation was $1,150, so your annual surplus for owning the property is $2,205. That means your weekly cash flow a positive $42.
As you can see, from a depreciation perspective, there are pros and cons of buying brand-new vs older or almost-new properties. Again, whilst a property’s likely depreciation deductions shouldnt be the main reason for a purchase decision, depreciation certainly has a significant impact on an investor’s cashflow equation.
Remember: To receive a FREE estimate of the likely deductions available to you on your investment property, whether new or old, click here!