50 -Building and depreciation allowances
Indirect property investments
It’s common for property trust returns to include a component said to be “tax-deferred”. The tax-deferred components arise when the trust’s income for reporting and distribution purposes is higher than its taxable income. This can be caused by high tax depreciation rates, tax building allowance deductions, pre-rental costs, costs incurred and certain equity raising costs.
In some cases the tax-deferred component can be 100% of the return. This means no tax is paid in that year. The amount is not described as tax free, because it will ultimately either be taxed (for example, when accounting depreciation moves above tax depreciation) or deducted from cost base (for example, building allowance amounts).
Tax deferrals benefit investors because they pay tax later. This means they have the use of what would otherwise be the tax money now, and this means higher compounded rates of return. In some cases paying tax later can also mean paying less tax, which is what happens if the investor’s marginal tax rate falls over the holding period.
A guide to tax deferred property investments
The Cromwell Property Group has released a handy guide to tax deferred property investments that includes examples to show how the tax deferrals work in practice, and how they are of benefit to investors and can “greatly increase the after tax return of an investment”.
You can down load this guide here: Cromwell Guide to Tax Deferred Investments.
We recommend you read this guide and that you provide a copy of it to your clients when you recommend property based investment trusts.
What about direct property investments?
The same principles apply to direct property investments although here the differences is usually only caused by accelerated depreciation rates and building allowance claims.
You can read the ATO materials on building allowances here: ATO materials.
You can read the ATO materials on depreciation allowances here: ATO materials.
Quantity surveyor’s reports
One of the most common tax mistakes is missing depreciation claims on assessable income producing properties, that is, rental properties or owner occupied business premises.
Most sale of property contracts will be silent about plant and equipment. The accountant will them show nil value for plant and equipment in the client’s tax return.
The 2.5% building allowance is often overlooked as well.
The accountant will say something like “but we have no documents to support the claim”.
That’s where quantity surveyor comes in. You should engage a quantity surveyor to prepare fresh depreciation schedules and building allowance schedules every time a client acquires an assessable income producing property. Your client can then claim depreciation and building allowance deductions based on these schedules in their tax returns.
One client was surprised to learn that the air-conditioner in his new factory in Reservoir in Melbourne was costed at $150,000. This created tax benefits of $45,000 cash over the next five years. The QS report cost $500. It was a great return on investment.
Send a copy of this page of this manual to every client who has an assessable income producing property and ask them to check their tax returns to make sure they are claiming depreciation and building allowance correctly.