Mistakes Landlords Make When Calculating Depreciation On Residential Properties
Depreciation is an important tax benefit for landlords. However, many landlords make costly mistakes. Mostly listening to mates & claiming or not claiming things they should. But sometimes it’s due to recent changes in Australian tax laws. We can’t help people that hang out with idiots. But we can help with understanding the rules around depreciation, especially the changes related to Division 40 (plant and equipment) and Division 43 (capital works). We can help landlords avoid these mistakes and maximize their deductions.
Not Understanding the Depreciation Difference Between Division 40 and Division 43
One of the biggest mistakes landlords make is misunderstanding the difference between Division 40 and Division 43. Division 40 applies to plant and equipment, which are removable items within a property. Division 43 covers capital works. These are structural improvements like buildings and renovations (Australian Taxation Office).
For example, appliances like stoves and air conditioners fall under Division 40. Meanwhile, structural aspects like walls, floors, and roofs are included under Division 43. Landlords who confuse these two categories may claim incorrect deductions, leading to issues with the ATO or missed opportunities to maximize tax savings. Watch out for the percentages!
Failing to Adjust for Recent Division 40 Changes
A major change to depreciation rules came in 2017, and many landlords are still unaware of its implications. Before this change, landlords could claim depreciation on both new and previously used plant and equipment in a second-hand property. However, the new law states that landlords who buy second-hand residential properties after 9 May 2017 cannot claim depreciation on existing plant and equipment (“BMT Tax Depreciation”). Did you know that?
As an example, this means that if a landlord buys a second-hand property with an old dishwasher, they cannot claim depreciation on that item unless it is replaced with a new one. Landlords who are unaware of this rule might attempt to claim depreciation on existing assets, risking penalties from the ATO. These guys mean business.
Overlooking New Plant and Equipment After the 2017 Changes
While landlords can no longer claim depreciation on existing plant and equipment in second-hand properties, they can still claim depreciation on new items they purchase for the property. However, many landlords forget to track and claim depreciation on new assets they install after purchasing a property. The changes make that likely. That’s all.
For instance, if a landlord buys a new hot water system or carpet, these items are still eligible for Division 40 depreciation. Failing to keep records of new purchases means landlords miss out on valuable deductions (“Real Estate Institute of Australia”).
Misunderstanding Division 43 Deductions for Older Properties
Many landlords think they cannot claim capital works deductions (Division 43) on older properties, but this is not always true. And get the tax on the property wrong. Many of our clients had nice responses from our QS! The rule is that landlords can claim capital works deductions on residential buildings that were constructed after 16 September 1987 (“McGrath”). Even if a property was built before this date, landlords may be able to claim deductions for renovations or improvements made after that time.
For example, if a property was originally built in 1980 but had major renovations in 1990, the cost of those renovations may still be depreciated under Division 43. Landlords who overlook these deductions are missing out on significant tax savings. The last one I saw personally was going to miss out on $250,000.
Failing to Adjust Depreciation After Renovations
Another common mistake is failing to adjust depreciation claims after renovating a property. Renovations create new opportunities for capital works deductions under Division 43. For instance, if a landlord adds a new bathroom or kitchen to their rental property, the construction costs can be depreciated over time.
Many landlords forget to update their depreciation schedules after making these improvements. As a result, they miss out on claiming deductions for the new renovations. To avoid this, landlords should get a new tax depreciation schedule from a quantity surveyor after any significant renovation (“BMT Tax Depreciation”).
Using Incorrect Effective Lives for Depreciable Assets
The ATO assigns a specific effective life to each depreciable asset, which determines how long an item can be depreciated. Some landlords mistakenly use incorrect effective lives when calculating depreciation for plant and equipment. This can lead to under-claiming or over-claiming deductions, which might trigger an audit (Australian Taxation Office).
For example, the effective life of an air conditioner is currently set at 12 years. If a landlord depreciates this item over 20 years, they are under-claiming the deduction. On the other hand, depreciating it over 5 years would result in over-claiming. Both scenarios could lead to problems with the ATO.
Incorrectly Claiming Deductions for Personal Use
Depreciation is only allowed for properties that are used to generate income. Some landlords make the mistake of claiming depreciation on properties they use for personal purposes. For example, if a landlord rents out a holiday home for part of the year and uses it personally for the rest, they cannot claim depreciation for the period of personal use.
The ATO requires landlords to apportion their claims when a property is used for both personal and rental purposes (Australian Taxation Office). Failing to do this accurately can result in over-claiming deductions and potential penalties.
Forgetting to Claim Depreciation on New Builds
New builds offer significant depreciation benefits. Both Division 40 and Division 43 deductions are available for new residential properties. Division 43 allows landlords to claim 2.5% of the construction cost of a building each year for up to 40 years. Division 40 lets them claim depreciation on plant and equipment within the property (“McGrath”).
Some landlords overlook these generous deductions, especially if they are not familiar with depreciation rules for new builds. Missing out on these claims can result in a significant loss of tax savings.
Not Updating Depreciation Schedules After Property Purchase
Many landlords purchase a property and assume they can use the previous owner’s depreciation schedule. However, every landlord’s depreciation situation is unique. If a landlord buys a second-hand property, they should obtain a new depreciation schedule to reflect their purchase price, any renovations, and the current condition of the plant and equipment.
Using an outdated schedule may result in under-claiming or over-claiming depreciation. A quantity surveyor can prepare a new schedule based on the landlord’s specific circumstances, ensuring accurate claims (“BMT Tax Depreciation”).
Poor Record-Keeping
Accurate record-keeping is essential when claiming depreciation. Landlords must keep detailed records of the construction cost, renovation expenses, and any new plant and equipment purchases. Without these records, the ATO may disallow depreciation claims, which can lead to costly penalties.
Many landlords fail to keep receipts and invoices for work done on the property. They also forget to update their records when they make changes to the property. This makes it difficult to claim the correct deductions. Maintaining good records helps landlords maximize their depreciation claims and stay compliant with tax laws (Australian Taxation Office).
Failing to Seek Professional Help
One of the most significant mistakes landlords make is trying to handle depreciation calculations on their own. Depreciation can be complicated, especially with the recent changes to Division 40 and Division 43 rules. Many landlords miss out on deductions or make costly errors because they don’t seek professional assistance.
A quantity surveyor can prepare a detailed tax depreciation schedule that maximizes a landlord’s deductions. This ensures landlords claim everything they are entitled to, and it reduces the risk of making errors that could lead to ATO audits or penalties (“Real Estate Institute of Australia”).
Summary of Common Mistakes
- Confusing Division 40 and Division 43.
- Claiming depreciation on second-hand plant and equipment bought after 2017.
- Forgetting to claim depreciation on new plant and equipment.
- Overlooking capital works deductions on older properties.
- Failing to update depreciation after renovations.
- Using incorrect effective lives for assets.
- Claiming depreciation on personal use properties.
- Missing out on depreciation for new builds.
- Using outdated depreciation schedules.
- Failing to keep proper records and seek professional help.
Conclusion
Depreciation is one of the most valuable tax benefits available to landlords. However, recent changes to Division 40 and Division 43 have made it more complex. Landlords must stay informed and ensure they are claiming the correct deductions. By avoiding the common mistakes outlined in this article, landlords can maximize their tax savings and stay compliant with the ATO.
The key to success is understanding the rules, maintaining accurate records, and seeking professional advice. With the right approach, landlords can fully benefit from the tax advantages of depreciation. With the right advice, you can do even better than that. Find out more. Reach out to us on 1 800 672 670.
Works Cited
Australian Taxation Office. “Rental Properties 2023.” Australian Taxation Office, 2023, www.ato.gov.au/General/Property/Rental-properties.
BMT Tax Depreciation. “Depreciation for Residential Property.” BMT Tax Depreciation, 2023, www.bmtqs.com.au/residential-property-depreciation.
McGrath, John. “Maximizing Your Depreciation on Residential Investment Properties.” McGrath Estate Agents, 2023, www.mcgrath.com.au/investment/depreciation.
Real Estate Institute of Australia. “Depreciation Changes: What Landlords Need to Know.” Real Estate Institute of Australia, 2023, www.reia.com.au/depreciation-changes.
Property Council of Australia. “Understanding Bonus Depreciation Opportunities for Property Investors.” Property Council of Australia, 2023, www.propertycouncil.com.au/tax/bonus-depreciation.