The Australian Taxation Office (ATO) has announced changes to the number and types of tax deductions available to investment property owners, including a clarification of which items in a rental property can be claimed as depreciating assets.
The changes are contained in a Draft Taxation Ruling, which offers an updated list of more than 150 individual rental property assets that can be classified as ‘depreciable’, provides the depreciation rates of these assets, and specifies how non-listed items should be treated.
In particular, the ruling takes a stricter approach to which items can be classified as depreciable and which must be treated as part of the building. This means a key area of the draft ruling is determining which assets in a residential rental property fall within Division 40 (for depreciating assets) and which are subject to Division 43 (for capital works) of the Income Tax Assessment Act 1997.
In the draft ruling the number of assets that can be claimed as a tax deduction (based on assets normally found in residential properties) has increased, and in some instances there have also been changes made to the period of time over which deductions can be claimed for those assets.
Depreciation of an asset allows a tax deduction for the cost over the asset’s life.
However, while the changes may benefit some investors, others may find that assets they have claimed for in the past are no longer eligible under the new depreciation rates, or else should not have been claimed for in the first place.
The ATO has also introduced a recommended useful life for dishwashers (10 years) and freestanding outdoor furniture (5 years), while other items have had their recommended effective lives changed, including hot water systems (reduced from 20 years to 12 to 15 years) and washing machines (increased from 6 2/3 years to 10 years). The changes to useful lives apply to assets acquired on or after July 1, 2004.
The ATO has also clarified its treatment of other items that owners might previously have classified as depreciating assets, such as kitchen cupboards, bathroom fixtures and water tanks, stating that the ATO regards these items as being capital works.
Despite the new expanded list, many property investors will still find it a complex process to determine which items fall within the category of ‘depreciable asset’ and which are defined as ‘capital works items’.
For instance, some elements of a renovation project may be classed as depreciable assets, but others would only be eligible for a capital works deduction at a rate of 2.5 per cent per annum on a prime cost (PC) basis.
In a kitchen renovation, for example, a new stove and a range hood would fall within the category of depreciable asset. The ATO suggests a useful life of 12 years for a stove, allowing depreciation to be claimed on the cost of the stove at the rate of 8.33 per cent PC or 12.5 per cent diminishing value (DV).
However, installing new kitchen cupboards would not fall into the ‘depreciating asset’ category as they are considered part of the building. The ATO would therefore only allow a 2.5 per cent capital works claim on these.
Similarly, a freestanding wardrobe has a recommended useful life of 13.33 years, allowing a depreciation rate of 7.5 per cent PC or 11.25 per cent DV, but a built-in wardrobe is classified as part of the building and is therefore only eligible for the capital works claim.
Owners can make their own estimate of an asset’s useful life, but such an estimate would need to be justified and fully documented. It may be safer to use the ATO’s recommended useful lives for all depreciable assets, unless special circumstances warrant making a self-determined estimate for particular assets.
It is strongly recommended therefore that owners of residential rental property seek specific advice from their accountants on their own circumstances to determine whether the depreciation and capital works deductions they claim for their properties are consistent with the new draft ruling.
This is particularly important if the depreciation and capital works claims are based on quantity surveyors’ reports (commonly provided where residential units are bought off-the-plan from a developer) that were prepared before the release of the draft ruling.
Peter Bembrick is a tax partner with accountants, business and financial advisers HLB Mann Judd Sydney.
12 August 2004