Depreciation Schedule Report for Your Property Development
Why You Need A Depreciation Schedule Report for Your Property Development.
This month, we spoke to Property Development specialist Mark Lawrence to explore the benefits of producing a depreciation schedule report in property development.
Below is an edited transcript of a conversation between Mark and Kerrian Devlin from Ventura iD Property Development in Perth.
Kerrian: Mark, let’s kick it off with outlining the benefits of what a depreciation schedule is.
Mark: A depreciation schedule outlines the depreciation elements of a building.
Traditionally land values appreciate, but the buildings or the improvements on them depreciate – that’s because overtime they wear out and eventually need replacing.
The tax office has provisions for people generating an income from property; it also provides the mechanism for the improvements on the property to be depreciated.
There’s various scales of depreciation for the different components in a building, but the main building itself, the actual base structure of the home, is able to be depreciated over a 40 year lifespan, at 2.5% annum.
In addition, with new properties, the chattels which include the carpets, the floor coverings, window treatments, even exhaust fans in bathrooms, remote controls, garage doors, garage door motors and such attract a different rate of depreciation based on the item.
The benefit of a depreciation report, which is generated by a licensed quantity surveyor, is that when you do your annual tax return, you also get a tax deduction for the depreciation on the construction or the build items on a home.
The advantage of having a brand new home is that it’s underappreciated from day one, so you’re going to maximise your tax benefits. The advantage is that you’re getting a return on your tax return without any cash up front.
Kerrian: So, for people who may or may not be familiar with it, what we’ve got is a scenario where somebody has, for arguments sake, rent coming in at $20,000, maybe their repayments might be $18000, making you a cash flow positive by $2,000 dollars.
So when you take into consideration the depreciation schedule, which for the example is $12 000, you are left with a paper loss of $10 000 that is a deduction from your gross income, therefore whatever tax bracket you fall into, you’ll be able to claim the deduction of $10 000 from your gross income.
You can in fact find yourself in a positive cash flow scenario and get cash back in your tax return.
Mark: Some research shows up to 80% of investment property owners are not taking advantage of this.
Kerrian: Why do you think that would be the case? Is that just ignorance?
Mark: I think it’s just a lack of information around it.
Obviously, with a lot of people too, especially those that have bought relatively new but not brand new properties might not be aware they’ll be entitled to some of those deductions.
If the home is up to 40 years of age, there is an opportunity to depreciate that building. By employing services of a quantity surveyor you will get some deductions.
Of course the main advantage is for people with brand new properties, so it’s essential to implement a depreciation schedule right when the constructions have occurred.
Kerrian: Why wouldn’t you just get your Accountant to work this out for you?
Mark: The Accountant knows the depreciation rates, but what they don’t have is the data on how much money is actually being spent on the property development project.
So with the building contracts and documents, the addenda and information from the Builder, the Quantity Surveyor will be able to extrapolate the data from there to determine the various components of the home.
Obviously a building itself is going to depreciate at a lower rate than interiors, like carpets.
These things may need replacing in 5 years, some other components might need replacing in 2 or 3 or maybe 10 years. So associated with all of those different items, the quantity surveyor will be able to provide a depreciation schedule for the accountant, so property developers and investors can put their deductions through in an accurate format.
Kerrian: There are two forms of depreciation that you can select. Do you want to discuss what those are?
Mark: There is straight line depreciation and then there is diminishing value.
The straight line is where you take, for instance the building, if we are saying at 2.5% depreciation over a time frame, it’s just a fixed amount based on the total value of the building itself, excluding chattels, and that’s a straight line depreciation that occurs over a 40 year time frame 2.5% year in year out that’s how it works.
Obviously the value the dollar depreciates over a period of time. 20 years ago you could be purchasing a house for $50,000, now you’re paying $200,000 for the equivalent product, likewise a $50,000 home with a straight line depreciation is going to be a smaller dollar figure.
With the diminishing value item, if an item is brand new, you are able to depreciate its value quicker, you don’t drive out of a caryard and see the value of the car diminish at an even rate over a time frame, it will diminish quickly in the first year, and then slowly reduction in the value will diminish. It’s the same things for carpets and other consumable items so they are able to be written off at a diminishing rate.
So what the quantity surveyor will do is break down the items within the building into straight line items and also diminishing value items.
Kerrian: So in effect, if you buy brand a new house, your depreciation would be much greater in the first and second year than it would be in say, in the 15th year, because those chattels you talked about would be depreciated in a more rapid rate up front, and be reducing to a point where there is no depreciation left because there it is time to replace them.
Mark: The upside to that, whilst there is higher depreciation in the early stages of the property, you’re also going to be getting a renter who is prepared to pay a premium to have a new home.
What will happen in ongoing years, with inflation and other factors, rent will increase, and depreciation will decrease because there is a higher component already written off, the advantage with having the depreciation in the early years of a property is that you can sustain the investment more easily in the early years.
Kerrian: Because of the tax relief.
Mark: Yes, and then after a time frame you’ll get the benefits of improved rent, which will also offset the reduced amount of depreciation over time which will enable you to hold the investment more comfortably.
Want to find out more about property development, and the tax benefits you’ll get from building a new residential development property?
Contact Ventura iD for a consultation with the team: ventura-id.com.au