If your SMSF is thinking about or has invested in property, you should be saving tax by claiming a depreciation deduction. Calculating depreciation on a property can be complex, so generally, in order to claim each year, you will need a tax depreciation report.
What is depreciation?
You generally cannot claim an instant deduction for the purchase of capital assets. Rather than claiming a deduction for the cost of the asset in the year that you purchased it, you claim the deduction over a number of years. A depreciating asset such as a building or building fixtures are assumed to have an effective life and decline in value over time and the amount and when you can claim and amount each year will depend on its effective life.
Types of Property Depreciating Assets
There are generally two types of depreciating assets that you can claim - capital works and plant and equipment.
Capital works (Division 43)
Capital works are the historical cost of constructing the building including initial building or extension of the building itself, construction of driveways or fences or Improvements to leased buildings. Considering the effective life of the asset, the depreciation is claimed over an extended period of time, usually 40 years but in some cases 25 years. This will depend on when the building was constructed. To find out which is applicable read more on the ATO’s website here - https://www.ato.gov.au/business/depreciation-and-capital-expenses-and-allowances/capital-works-deductions/
To be eligible to claim this deduction you must have:
details of the type of construction
the date construction commenced
the date construction was completed
the construction cost (not the purchase price)
details of who carried out the construction work
details of the period during the year that the property was used for income producing purposes
In some circumstances, you may be able to use an estimate to determine the cost price if you cannot get hold of the above information.
Plant and Equipment Items (Division 40)
Plant and Equipment items are those items that are easily removable from the property. As with the building, each item has an effective life that can be used to determine how much depreciation can be claimed each year. There are two methods that can be used. Prime cost method is where you claim the same amount each year over the effective life or the more popular diminishing cost method where more of the depreciation is claimed in the earlier years of its effective life.
In a residential property, the most common plant assets are:
Hot Water Systems
Eligible plant and equipment items with a cost of $300 or less qualify for an immediate full deduction in the year that they are purchased.
How Do You Claim Depreciation?
If you want to claim depreciation, you will need to put together a formal depreciation schedule. This sets out every depreciating asset in your property. You can do this yourself, but this can very time-consuming and easy to get wrong. The ATO does provide a comprehensive list of effective life estimates for each depreciating assets. This project will not be just a one off at purchase time but would rely on you doing a reconciliation each year. Most Trustees would not even consider taking this on and prefer to engage a Quantity Surveyor to prepare a Tax Depreciation Report that you can give to your SMSF Administrator.
What is a Tax Depreciation Report
A Tax Depreciation Report sets out the depreciation entitlements available to your SMSF on each of its investment properties. Most properties can have a tax depreciation report and a Quantity Surveyor can help you determine if it is cost effective for your particular property. A Quantity Surveyor prepares the Tax Depreciation Report and they are one of only a few professionals that the ATO will allow to estimate construction costs. Tax Depreciation Reports should include:
40-year forecast illustrating all depreciable items
Both prime cost and diminishing value methods of depreciation
The effective life and depreciation rate for all division 40 (plant and equipment) assets
Low value and small business entity pools and instant asset write-off
Generally, the ATO lets property investors deduct the cost of depreciation from their overall income. This means, as a property investor, you could be enjoying significant tax savings at the same time as your property investment grows.
Benefits of obtaining a Tax Depreciation Report
The cashflow benefits can be significant. So much so that the tax benefits your SMSF can get from obtaining a report may be the difference between a positive or negative return and can be used by a mortgage broker to determine borrowing capacity for a Limited Recourse Borrowing Arrangement (LRBA). These tax savings can be re-invested through to retirement.
The report also lasts for the life of the investment. Once you have handed it to you SMSF Administrator, your work is done – no need to maintain a spreadsheet or keep track of your depreciating assets. If you did not get a report done at the time of purchase, you can get it done now and have your previous tax returns amended (up to 4 years).
An often-overlooked report that can save you time and money, a Tax Depreciation Report is well worth your time and investment to ensure that you do not miss deductions for your SMSF.
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