Rental residential Property Depreciation Changes
The Government has finally released the draft legislation to change entitlements for depreciation in respect of residential rental properties.
The proposed changes aim to reduce the amount of tax deductions a second hand residential property investor can claim for previously used depreciating assets. These changes will not affect investors who purchase properties off the plan, or when substantial renovations are completed.
The legislation, which is yet to be enacted, will prevent taxpayers from claiming tax depreciation deductions for the wear and tear from assets, fixtures and fittings that existed when they purchased the property ‘second hand’.
Historically, a depreciation deduction was able to be claimed for assets acquired as part of a residential investment property purchased, even if those assets were installed by the previous owner. The residential property investor could obtain a quantity surveyor’s report (“QS Report”) to determine the historic cost and effective life remaining of any assets that may form part of the property when purchased, and claim a tax deduction over the remaining life of the assets. This essentially, provided the investor with a non cash tax deduction for an estimated prior spend by a former owner of the property.
For example, a property purchased with an air conditioner would have been entitled to determine the depreciable value remaining (if any) and the owner would then claim a tax depreciation over the remaining life of the asset. The proposed law changes this such that the property owner would be denied a tax deduction for the depreciation on the assets acquired as part of the purchase, however, remains able to claim a deduction for items physically purchased.
Contrary to the initial thoughts, the existing treatment for pre existing investment property owners has been retained. Furthermore, any investor who is now unable to claim a tax depreciation deduction on second hand assets because of these changes may be able to attribute any undeducted value to the cost base of their investment when the property is eventually sold (reducing a potential capital gain). In this regard, a QS Report would still be valuable as it would need to be obtained to correctly determine the undeducted written down value of the assets and the cost of the property for capital works deductions.
Capital works deductions are not impacted by the changes and therefore the undedicated construction cost of a property is still able to be depreciated by purchasers of rental properties.
As noted above existing investments will be grandfathered, meaning those investors who purchased their second-hand properties before 9 May 2017 will still generally be able to claim depreciation as per normal. If the property is brand new, the rules for depreciation of assets, fixtures and fittings will be the same as they were previously.
Should you need assistance in relation to this matter, please call your relevant ESV engagement partner on 02 9283 1666.