Most homeowners and investors may have negative perceptions about depreciation. That’s likely because the term is loosely defined as a decrease in property value, and sellers must keep it to a minimum when dealing with residential property for sale.
While residential property depreciation refers to a reduction in asset value, the good news is that owners may claim a portion of the amount to offset tax liabilities. For example, rental property owners who’ve spent on improvements may recoup some of their expenses based on specific and applicable tax schedules and guidelines. As such, it’s crucial to know how residential property depreciation works.
In this blog, you’ll learn the basics of property depreciation and how to calculate it.
What is a residential property?
Before discovering what depreciation means, it’s crucial to know the definition of residential property to understand how it applies to homeowners and investors. Note that residential property definition may vary slightly from country to country, where applicable tax rules differ.
According to the Australian Tax Office or ATO, a residential property includes houses, flats, units and other dwelling places where occupants can take shelter and where living facilities are available. A residential property may either be occupied or has yet to be occupied, excluding vacant land.
Besides physically buying a residential property, investors with lesser funds can also invest in real estate through exchange-traded funds (ETFs). A residential property ETF is a fund tied with the leasing, managing and acquiring of residential real estate properties.
How does property depreciation work?
Residential property depreciation is a cost reduction method allowing investors to leverage their property’s reduced value and expenses against their taxable income. A residential property valuer can help owners identify the things they can claim depreciation for.
Generally, they come from these two primary sources:
Capital works depreciation covers the structure’s value, including permanently affixed items. This could include the roof, walls, toilets, sinks, kitchen, etc. Investors who’ve had houses built after September 15, 1987 can offset 2.5% of these items for up to forty years. Moreover, prior properties, especially those that have undergone significant renovations, may also be eligible for reductions. Ask concerned residential property developers for additional information about your property if you haven’t yet.
Plant and equipment
Plant and equipment depreciation includes removable fittings and items within the property that increases its value. You’ll need assistance from a residential property valuer and a surveyor to help you on this, as the ATO accepts over 6,000 items under this classification. Appliances, carpets and air conditioners are only a few of the products under this category.
Each article has its specific effective or useful life and corresponding rates for depreciation claims. Typically, easily damaged products have lower claim validity and higher diminishing value rates.
Previously-occupied residential properties sold past May 9, 2017 aren’t included in this tax reduction claim. Conversely, the ATO accepts plant and equipment depreciation claims for newly built, renovated, and recently-furnished assets.
How to calculate residential property depreciation
In calculating asset depreciation, it’s best to talk with an accountant to determine which works better for you as an owner or investor. There are two ways to do it:
- Prime cost: This approach is anchored on the principle that property depreciation values don’t change over the asset’s effective life. It’s calculated based on the following expression: Property’s cost × (days held ÷ 365) × (100% ÷ useful life). As such, you’ll claim the same amount for the whole duration.
- Diminishing value: This method assumes depreciation is faster during the asset’s early life. As an owner, you’ll be claiming varying amounts, which reduces yearly. It can be computed using this formula: Base value × (days held ÷ 365) × (200% ÷ useful life).
Other basic information about property depreciation filing
After identifying which assets you can claim depreciation for, the next step is determining the structures that qualify for tax deductions. However, note that this exercise may include technical expertise at some point, so it’s best to seek help from professionals like residential property developers Sydney has on its list or from similar contractors near you.
- Owners who had their properties remodelled recently can file; however, the building must have been built after February 1985. In such cases, the ATO has to be informed of the renovation cost. If the previous owner was responsible for the renovation, contact them. Otherwise, you may ask a surveyor for professional approximations.
- For newly built and significantly renovated properties, it’s best to work with residential property developers and surveyors to determine the residential property’s accurate depreciation figures.
Accountants are often considered rockstars during tax seasons. If you have a residential property in Australia, it also pays to work with quantity surveyors who can evaluate construction work value. They can help you identify residential property depreciation rates for your taxable assets.
Property owners can comply with the rules by working with these experts while reducing their annual tax obligations. Doing so saves investors money and provides opportunities to diversify their portfolios.
⦁ Australian Tax Office. 2022. GST and residential property. ⦁ www.ato.gov.au. https://www.ato.gov.au/business/gst/in-detail/your-industry/property/gst-and-residential-property/. Accessed 19 August 2022
⦁ National Australian Bank Limited. 2022. How depreciation works for a new investment property. ⦁ www.nab.com.au. https://www.nab.com.au/personal/life-moments/home-property/invest-property/claim-depreciation. Accessed 19 August 2022
⦁ Hyde, T. 22 June 2022. A guide to investment property depreciation. ⦁ www.realestate.com.au. https://www.realestate.com.au/advice/property-depreciation-101/. Accessed 19 August 2022
⦁ H&R Block. 2022. A Beginner’s Guide To Property Depreciation. ⦁ www.hrblock.com.au. https://www.hrblock.com.au/tax-academy/beginners-guide-to-property-depreciation. Accessed 19 August 2022