THOSE OF YOU considering the purchase of an investment property often ask whether a commercial or a residential property will provide them with more deductions in the form of depreciation.
As you will appreciate, there are many important factors an investor needs to be aware of – when making your choice between these two investment options.
Types of Depreciation – how the rules change
Depreciation deductions apply to investment properties in two ways.
Deductions can be claimed for the depreciation of the building structure known as a capital works deduction, and for the plant and equipment assets* contained within the property.
For a commercial investment property, the commencement date the Australian Taxation Office (ATO) allows investors to claim the available capital works deductions, (structural items such as the bricks, building and roof) is the 20 July 1982.
Whereas, for residential properties, capital works can only be claimed for properties in which construction commenced after the 15 September 1987.
And depending on the age and type of building, you can claim either 2.5% or 4% annually of the property’s historical construction cost for the capital works allowance.
The deductions for plant and equipment assets (contained in both residential and commercial properties) will depend on the individual effective lives of each asset as set by the ATO.
In the case of residential properties, it also depends on the purchase date of second-hand properties*.
However, the ATO does deem that some assets used in one commercial industry may depreciate at a higher rate than they would in a residential property or even a different commercial industry.
Perhaps one example of such an asset would be “carpets” – because they will depreciate at a higher rate in restaurants and pubs … than in retail office buildings, or residential dwellings.
In Commercial properties, Tenants can also claim
Commercial tenants are able to claim depreciation on any fit-out they add from the starting date of their lease.
This can include assets such as desks, blinds, shelving, carpet, vinyl, fire fighting equipment and security systems.
If a commercial tenant removes items at the end of their tenancy and disposes of the item, they may also be able to claim the remaining depreciation for assets removed and scrapped when they vacate the property. However, if the owner of the asset decides to on-sell items installed or keep them for future use, this does not apply.
In cases where items are on-sold, tenants should always discuss this with their Accountant – as this may have other tax implications.
You should note that commercial building owners are also entitled to claim depreciation of assets installed and left behind by a previous tenant, once a tenancy has ceased. Therefore, it is important to contact a Quantity Surveyor to ensure that each party makes their claim correctly.
Rules about Claiming and Occupancy of the property
ATO Legislation states that a residential property owner cannot claim depreciation for a building they themselves solely occupy. They can only claim depreciation on a building that is income producing.
However, in a commercial property, there are ways that the owner can occupy the investment property and still be able to claim depreciation.
For example, if the property is purchased by a company or a trust, the owner may still be able to occupy the premises as a tenant and claim property depreciation.
It is also worth mentioning that the ownership structure can have an impact on what marginal tax rate when making a depreciation claim.
Bottom Line: No matter what type of property you choose to buy, it is recommended you contact a specialist Quantity Surveyor for further advice on the depreciation applying to that building.
Quantity Surveyors arrange a site inspection, take measurements and estimate the structural costs as well as assess what plant and equipment items the building contains. They will then provide a tax depreciation schedule outlining all of the depreciation deductions available for the property owner’s annual tax assessment.
* Under new legislation outlined in the Treasury Laws Amendment (Housing Tax Integrity) Bill 2017 passed by Parliament on 15 November 2017, investors who exchange contracts on a second-hand residential property after 7:30pm on 9th May 2017 will no longer be able to claim depreciation on previously used plant and equipment assets. Investors can claim deductions on plant and equipment assets they purchase and directly incur the expense for. Investors who purchased prior to this date and those who purchase a brand new property will still be able to claim depreciation as they were previously.
To learn more, read BMT’s comprehensive White Paper.