2017 Budget Comment – Who will require a Tax Depreciation Schedule?

On Budget night, 9 May 2017, the Government proposed changes to the depreciation of plant and equipment items (Division 40 Items) for investment properties.

First and foremost, property investors who entered into contracts to acquire a property prior to 7:30pm 9 May 2017 are not affected by the proposed changes.

Broadly speaking, the proposed changes will make existing (pre-owned) investment properties less attractive to investors because, where the client enters into a contract to acquire a residential investment property after 7:30pm 9 May 2017, the investor is no longer able to claim significant* depreciation deductions on the plant and equipment items that came with the property. The following endeavours to add clarity to the future of the Tax Depreciation Schedule, specifically, when is one required.

It is important to note that Tax Depreciation Schedules comprise three parts; depreciation on the plant and equipment (Division 40), depreciation on the building (Division 43) and non-depreciable items.

For the unversed, Division 40 items comprise appliances, air conditioning equipment, light fittings, fans, smoke detectors, carpets, vinyl, blinds, hot water systems, automatic door motors, pumps, lifts, pool equipment, etc. Non-depreciable items include site preparation, demolition and soft landscaping. And, Division 43 items are typically what’s remaining i.e. the building structure, slab, walls, ceiling, roof, tiling, painting, joinery, plumbing works, electrical wiring, etc as well as external works, driveways, fencing, paving, pergolas, pools, etc.

In order to claim a deduction for Division 43 depreciation, the services of a Quantity Surveyor are required as the ATO recognises that Quantity Surveyors are suitably qualified and experienced to provide the estimate of original construction cost which forms the basis of the Division 43 deduction. Even where the construction cost is known i.e. in situations where the property investor engages a builder to construct the house, the preparation of a Tax Depreciation Schedule by a Quantity Surveyor is recommended because the knowledge and experience of the Quantity Surveyor is required to break down the construction cost into the depreciation categories as well as taking into account the apportionment of distributable costs like builder’s preliminaries and overheads, consultant’s fees and council fees.

Division 43 depreciation applies to residential properties constructed post 18 July 1985. The applicable Division 43 depreciation rate for the period 18 Jul 1985 to 15 Sep 1987 was 4%/year which means that, whilst qualifying for Division 43 depreciation, the depreciation has typically expired for properties constructed within this period. Hence, for the purpose of the below analysis, we are essentially only looking at properties constructed post 15 Sep 1987 when the depreciation rate was reduced to 2.5%/year.

So, let us review the proposed changes taking into account the various scenarios (note, the following scenarios are based on properties where contracts are entered into post 7:30pm 9 May 2017. Again, properties, where contracts were entered into prior to 7:30pm 9 May 2017, are not affected by the proposed changes):

1. Existing residential property constructed prior to 15 Sep 1987 that has not undergone any Division 43 capital improvements – These properties will not require a Tax Depreciation Schedule. However, in reality, a Tax Depreciation Schedule for such properties was always at the discretion of the property investor because, even under the existing Legislation, the owner was capable of depreciating the Division 40 plant and equipment items themselves (with the help of their accountant) under the rules of ‘self-assessment’. A fact that was not lost on Redline Quantity Surveyors who relayed this exact message to hundreds (if not thousands) of clients over the years.
2. Existing residential property constructed prior to 15 Sep 1987 that has undergone Division 43 capital improvements – These properties will require a Tax Depreciation Schedule in order to claim depreciation deductions on the cost of the Division 43 capital improvements, however, the viability of the Schedule will come back to the extent of Division 43 capital improvements completed by the previous owner and the timeframe that the current owner intends to keep the property.
3. Existing residential property constructed post 15 Sep 1987 – Assuming the details of the Division 43 allowances are not passed on by the previous owner, these properties will require a Tax Depreciation Schedule because they qualify for Division 43 depreciation and, as mentioned above, the Quantity Surveyor is required to prepare the estimate of the original construction cost. The format of the Tax Depreciation Schedule will change for these types of properties as there is longer the requirement for a detailed plant and equipment schedule.
4. New residential property – Based on the assumption that, when buying a new property the property investor will be entitled to claim the Division 40 plant and equipment depreciation, then nothing has changed for these properties and a full Tax Depreciation Schedule is required.

We trust the above clarifies the proposed changes and the effect they will have on Tax Depreciation Schedules moving forward. For any further information, please contact Simon Hanau of Redline Quantity Surveyors, Phone 1300 732 667.

*As an indication (only) as to the impact of the recent changes, and the approximate monetary value that will be foregone by investors, I have taken a look back at some recently completed Tax Depreciation Schedules for secondhand properties and found that there was an average of $16,000 in plant and equipment items per property. Furthermore, another Tax Depreciation Schedule completed recently for an unfurnished multi-million-dollar high-rise unit included over $85,000 in plant and equipment items.