Don’t hate, depreciate
Capital gains have taken centre stage in the minds of many Australian property investors due to strong real estate market conditions in many locations. However, long-term investors know that capital gains are not the only factor in an investment strategy. When it comes to real estate investment, yield is also important.
The amount that an investor can rent a property out for has many drivers. These include the location of the property, its size and quality and proximity to amenities such as schools and employment. In order to receive higher rent from an investment, investors are often left with just two choices: they can either wait for the market to rise or they can undertake improvements to the property in the hope that it will attract a higher rent.
However, investors can also increase a property’s yield by reducing the amount of tax that they pay on income generated by the property. Although this doesn’t affect the gross yield of the property, it does affect the amount of yield that the investor receives in the hand. Investors often claim property management fees, borrowing expenses, repairs, maintenance, strata, council rates and pest control costs.
There is another aspect of reducing tax and increasing net yield that many investors overlook – tax depreciation. Not only are many people unaware of the of the benefits of tax depreciation, research conducted by BMT Tax Depreciation suggests that up to 80% of property investors who claim tax depreciation may be not be doing so correctly. This means that there are potentially thousands of investors who are not getting the right tax return.
What is tax depreciation?
Quantity surveyors are able to create schedules which detail the depreciation deductions available for both the building structure and the plant and equipment items contained within a property. The Australian Taxation Office allows people who invest in income-producing properties to claim this depreciation, which reduces their taxable income and results in a tax saving.
Claiming tax depreciation can make a substantial difference to the net yield of a property and, for some investors, it may even make a particular property a viable option.
Although investors can claim a high amount of depreciation from new homes, existing homes can also yield substantial depreciation claims for their owners.
How can tax depreciation help you?
Consider the case study below in which a property investor was able to identify an additional cash flow of $4,992 from a ten-year old property by using tax depreciation.
After finding a property priced at $560,000, the investor had the rental income appraised at $530 per week, or $27,560 per year.
The budgeted expenses associated with the property amounted to a total of $36,060. This included interest, property management fees, maintenance, repair costs and council rates.
After calculating these costs, the investor contacted a quantity surveying firm in order to receive an estimate of the likely depreciation deductions they could expect from the property. They found that it was likely they could claim approximately $13,500 in the first full year.
The following table provides a summary of these costs and the investor’s annual position depending on whether or not depreciation is claimed.
The table shows that if the investor chose not to claim depreciation, they would have a weekly cost of $103. However, if the investor decides to claim depreciation, the weekly cost would only be $7, a difference of $96 per week or $4,992 in the first year.
What do I do now?
Whether you own one investment property or a portfolio of investment properties, tax depreciation can make a difference to your cash flow.
Those who already own an investment property but have not claimed tax depreciation in past years are able to adjust the previous two years of returns. This has yielded huge financial gains for many of our clients, often in the tens of thousands of dollars.
Many property investors already claim tax depreciation, which is great news. However, if you feel that your quantity surveyor may have missed something, you can also amend your previous two tax returns and possibly get a refund.
If you are looking to buy an investment property, make sure that you receive an estimate of the likely depreciation deductions that you could expect to receive from the property. There are some great tools available online such as depreciation calculators and apps for free download that are worth investigating.
Tax depreciation might just provide you with a windfall that you weren’t expecting.
Bradley Beer (B. Con. Mgt, AAIQS, MRICS) is the Chief Executive Officer of BMT Tax Depreciation.