Why you need a depreciation schedule when the construction cost is known

At first glance, this seems like a reasonable question and it’s one we’re asked by residential investors and commercial clients all the time.

I’ve written on this topic before but I’m sure in my usual style I went into too much detail and tangential metaphors.

Let’s make it very simple in the following example. Depreciation

Say you’re a residential investor and you engage a builder to build you a house for use as an investment.

The builder draws up the plans, provide the inclusions and specifications to your satisfaction, and agrees to a fixed price of $300,000.

Any ideas what the total deductions are going to show over the life of the property?

That’s right, $300,000! (I’m keeping it simple an assuming there are no non-depreciable components).

So, what’s the point in getting a depreciation schedule that tells you exactly what you already know?

Well… nothing of course, but it’s what you don’t already know that matters.

What you won’t know is the breakup of that $300,000.

Occasionally a builder may provide some of the appliance’s costs (this is unusual), and you may decide to select and pay for some of the assets as part of the contract, but you’re unlikely to know the value of the following;

  • Air Conditioning
  • Blinds
  • Ceiling Fans
  • Door Closers
  • Exhaust Fans
  • Floor Coverings
  • Hot Water Systems
  • Kitchen Appliances

More – There are well over 100 assets that fall into a differing tax category with high rates of depreciation, especially within common areas 

investor-needs-to-know-about-finance-tax-and-the-law

Why would you need to know the value of these assets? Because without them your maximum depreciation rate is 2.5%.

That is the depreciation rate for what we tax nerds call division 43 capital allowances.

That relates, in general, to anything classified as the building structure like concrete, tile and timber.

The other assets are plant and equipment items that can have depreciation rates as high as 100% but average a little closer to 30%.

So, let’s make it real, with a hypothetical case study (yes that was meant to sound stupid, but just trust me for a second).

If you don’t itemise plant and equipment items, your maximum yearly depreciation would be $7,500.

That is 2.5% of $300,000 per year.

If we take a typical view of the plant and equipment items that would be in an average four-bedroom house with a $300,000 construction cost, the first-year depreciation total now comes to $13,852

That’s a significantly different tax position that could result in an extra $2,000 or more back in your pocket.

Tax DepreciationYet the total construction cost remains the same.

Technically if you retain the property as an investment for forty years, your net tax position will be the same. However, that ignores the time value of money and the statistics telling us that investors sell their property within 10 years.

In fact, according to CoreLogic’s research, investors keep their houses between 6.1 and 9.1 years.

Taking the figures from our case study, itemising the plant assets results in an extra $21,989 worth of deductions over the first five years of ownership.

In closing, you may know the total construction cost, and if so you certainly don’t need someone to estimate it for you.

However, itemising assets into their respective categories is where a quantity surveyor pays for themselves very quickly.

Bringing those deductions forward increases your cashflow and ensures you’re not missing the bulk of the claims if you sell the property down the track.

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About

Mike Mortlock is a Tax Depreciation expert, Quantity Surveyor and Managing Director of MCG Quantity Surveyors. He is a regular speaker and commentator having been featured in the Financial Review and Sky Business. MCG Specialise in Tax Depreciation Schedules and Construction Cost Estimating for investors. You can visit them at Visit www.mcgqs.com.au


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