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Don’t forget property related tax deductions

If you own residential investment property in your SMSF, there are plenty of legitimate deductions to which you may be entitled, which can be used to reduce your fund’s taxable income.

Depreciation and capital works

One of the deductions most often missed is depreciation and capital works allowances.

If the property was built before 16 September 1987, the owner can claim depreciation on the plant and equipment – the oven, dishwasher, blinds, carpets etc – but not the building. The plant and equipment must be depreciated at varying rates subject to the “effective life” of the asset.

If the property was built after 16 September 1987, the capital works allowance comes into play, and the owner can claim depreciation on the actual building – the brickwork, the concrete etc. – as well as the plant and equipment.

Your total capital works deductions cannot exceed the construction expenditure. If you have bought a rental property off-the-plan, no deduction is available until the construction is complete.

Two ways of working out depreciation

Depreciation and capital works allowances must be claimed over a number of years. You can work out your deduction for the decline in value of a depreciating plant and equipment asset using either the prime cost or diminishing value method. Both methods are based on the effective life of the asset.

The prime cost method assumes that the value of a depreciating asset decreases uniformly over its effective life. The diminishing value method assumes that the decline in value each year is a constant proportion of the remaining value and produces a progressively smaller decline over time.

The Australian Taxation Office (ATO) has a handy guide to the taxation treatment of rental income and expenses here [1] that explains how to calculate both these methods.

These deductions are not as handy to an SMSF as they are to a non-super investor on a higher tax rate, but while your fund is in accumulation mode and taxed at 15% on its earnings, you should ensure that you identify and use every cent of depreciation allowance to which you are entitled. Paying more tax in your SMSF than you legally should pay is a mug’s game.

Depreciation schedule

Every owner of an investment property should prepare a depreciation schedule, to make a thorough list of all the things for which they can claim. This schedule should note all of the things that the owner has done to the property, or things that were done to it in prior years. Even if a previous owner renovated the property before your fund bought it, your SMSF is still entitled to claim depreciation.

The best thing to do is engage a quantity surveyor to do this job. Not only is the quantity surveyor highly likely to find you extra deductions, if they find that you’ve missed one from prior years, in conjunction with your accountant they can lodge an amended prior-year return as well – up to two years’ back.

A common misconception is that just because you have bought an older house – say, a 1970s house – there is no point getting a depreciation schedule prepared.  But there is, because you have paid for the plant and equipment within that property: for example, there is still value attached to that oven, those blinds and those carpets.

The capital works allowance (also known as the building allowance) can be a bit more complicated. On a brand-new house, the capital works allowance is claimable for 40 years from the date of completion.

If your fund builds a house today and it costs $200,000, within that house there might be $20,000 worth of plant and equipment – the ovens, dishwashers, blinds etc – that you can depreciate at varying annual rates.

The brickwork and concrete might represent $180,000 – you could claim that at the fixed capital works deduction rate of 2.5 per cent, or $4,500, for 40 years. But if your fund buys an investment property that was built in 1993, you could still have 20 years of deductions left.

Renovations

Using a quantity surveyor is particularly important in the case of renovated property: if you do not know the cost of renovations done before your SMSF bought the property, the quantity surveyor is fully qualified to make an estimate that will be acceptable to the ATO.

If your SMSF is renovating an investment property – which under the ATO’s final ruling SMSFR 2012/1 it can provided it is not using borrowed funds for the renovation – there is likely to be residual value, and thus unclaimed depreciation, on any plant and equipment you replace. You may be able to claim immediate deductions for elements of the property you remove: but if you do not know the cost of what you have pulled out, you might not be able to claim for it.

Another reason for using a quantity surveyor is constant changes to what can be defined as plant and equipment, and what is considered necessary in order to make the property available to be rented out.

If your depreciation report calculates your total depreciation in year one as $10,000, the tax benefit to your SMSF is worth 15% or $1,500. Clearly that is not as beneficial as the $4,650 that the same depreciation amount would be worth to a non-super investor on the highest marginal tax rate, but it is $1,500 that stays in your SMSF and does not go to the ATO. You can maximise the benefit by buying property in an area where the rent is relatively high.

The other point to make is that by the time your SMSF is in pension mode and not taxed, there is no point in a depreciation schedule, because you do not need tax deductions.

The above was compiled with the assistance of Tyron Hyde, director of quantity surveying firm Washington Brown.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.