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By Paul Palella of Property Wealth Australia Pty Ltd.
For many investors real estate will continue to be at the forefront of their investment strategy to ensure wealth creation. The reasons for this are often simple: investors feel that they have more direct control over their investment, as far as investments go, real estate is easy to understand; and most feel that they can add value to their investment by making improvements to the property.
Many investors have over the years created significant wealth through careful investment in real estate. One of the ways they do this is by claiming allowable depreciation on the investment properties. I am often surprised at the number of real estate investors who could be saving thousands of dollars each year by making the allowable claims for depreciation.
Tax depreciation is one of the property investor’s tools for maximizing wealth creation.
What is Depreciation? Depreciation is a reduction in value of an asset or commodity. For example, with an investment property you can break the property up in to a number of categories. Firstly the land on which the property is built, secondly the building or dwelling that is on the land and thirdly the fittings inside the dwelling such as washing machines, stoves, dishwashers etc.
The physical value of the dwelling and the fittings as component of an investment property are said to depreciate due to the effects of wear and tear. In accounting terms, depreciation involves the writing down of the cost of these assets over the anticipated useful life.
The Division 43 Construction Allowance (Income Tax Assessment Act 1997) qualifies if your investment property was built after July 1985 and amounts to either 4% or 2.5% of your portion of the construction costs of the whole unit complex or dwelling. In addition to this claim, plant and equipment such as carpet, light fittings, white goods, air conditioning, fire hose reels etc. can be depreciated at rates ranging from 5% - 20% of their cost. The best way to explain the benefits of depreciation to an investor is by way of a simple example:
Bob is paid a base salary of $75,000 per annum, plus superannuation. Bob has just invested in a near city apartment for $300,000 knowing that he can rent the apartment at $300 per week.
Expenses include a rental manager’s fee which amounts to 8.0% of the gross rent and additional expenses including rates, insurance, body corporate fees and other costs totaling $3,000 per annum.
Bob's property came with a furniture and fittings fitout valued at $30,000 This fit out included furniture, soft floor coverings, floating timber floor, vertical blinds and kitchen appliances. These assets have an averaged expected useful life of ten years from the date of first use. He is also entitled to a Division 43 construction allowance based on a building construction cost of $180,000 as determined by a suitably qualified Quantity Surveyor. Bob’s property is financed via an 83% loan ($250,000) at an interest rate of 6.50% per annum (interest only) which equates to a loan repayment of $312.50 per week. Using this information and adopting the prime cost method of depreciation a qualified Quantity Surveyor can calculate the allowable deductions and report these in a depreciation schedule. This information is then included in the end of financial year return by the investor’s accountant.
Summary of Property Income & Expense
For the End of Financial Year
Item
| Amount
| Rental income
| $15,600
| Rental Management
| ($1,248)
| Loan Interest
| ($16,250)
| Rates etc.
| ($3,000)
| Cash flow Loss
| ($4,898)
| Fit out depreciationA
| ($3,000)
| Capital works deductionB
| ($4,500)
| Tax Loss
| ($12,398)
|
A. $30,000 x 10% = $3,000 (assessed by engaging Property Wealth)
B. $180,000 x 2.5% = $4,500 (assessed by engaging Property Wealth)
Given the details above, a summary of Bob's tax position is:
| Bob with no property
| Bob with investment property
| Salary
| $75,000
| $75,000
| Property tax loss
| -
| ($12,398)
| Taxable income
| $75,000
| $62,602
| Total Tax + Medicare
| ($22,087)
| ($16,444)
|
Using this information we can calculate an after-tax summary to establish whether or not Bob has created wealth with his property investment.
| Bob with no property
| Bob with investment property
| Salary
| $75,000
| $75,000
| Cashflow loss
| -
| ($4,898)
| Income tax
| ($22,087)
| ($16,444)
| After-tax cash flow
| $52,913
| $53,658
|
CONCLUSION
Despite the fact that the property brings about a negative cash flow, Bob nevertheless has more after-tax income available ($53,658 compared with $52,913) as a result of buying this property and choosing to use the services of Property Wealth to prepare an accurate depreciation schedule.
Combining the above information, we can make a comparison of Bob’s after tax cash flow with an investment property, with an investment property but no Tax Depreciation Schedule and Bob without an investment property:
| Bob with Property but with out Meridian report
| Bob with no property
| Bob with Property and Meridian report
| Salary
| $75,000
| $75,000
| $75,000
| Cash flow loss
| ($4,898)
| -
| ($4,898)
| Income tax
| ($19,711)
| ($22,087)
| ($16,444)
| After-tax cash flow
| $50,391
| $52,913
| $53,658
|
PROPERTY WEALTH
At Property Wealth we are committed to helping property investors maximise the return on their investment (ROI) through the provision of Taxation Depreciation Schedules for investment properties. Taxation Depreciation Schedules Many investors are able to improve the return on their property investment and produce a healthier cash flow by maximising the available tax deductions. At Property Wealth our core focus is on preparing Taxation Depreciation Schedules for property investors. Our research is ongoing, keeping us up to date with the continually changing legislation that relates to construction and depreciation claims. Our studies have shown that property investors who do not engage the services of a suitably qualified Quantity Surveyor to accurately prepare a depreciation schedule are missing out on claims ranging $3,000-$15,000 per annum. Can you afford not to benefit from this claim? If you would like further information in relation to tax depreciation or for a no obligation quote please contact Property Wealth Australia Pty Ltd on 1300 737 042.
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