As a first-time property investor, we’re sure you have heard that tax depreciation deductions, specifically capital works deductions, are typically one of the largest tax deductions you can claim as a property investor in Australia.
But it can be quite overwhelming navigating through the different claimable tax depreciation deductions.
For example, you may know that there are two different depreciation methods, but you aren’t sure if it’s best to use the diminishing value method or the prime cost method.
You know that there are several types of assets on which you can claim depreciation deductions, but are they capital works assets, or are they classified as plant and equipment?
So, how is the effective life different for all these assets?
This article aims to help you navigate through all these questions and equip you with everything you need to know about a capital works deduction and how it influences your construction cost.
What Is Division 43 Property Tax Depreciation?
Every property investor should be familiar with property tax depreciation. As a building ages, its structure and the depreciating assets within it are subject to general wear and tear, leading to a decrease in value or depreciation.
The Australian Taxation Office allows property investors who generate income from their properties to claim deductions for the depreciation of structural items under capital works deductions, thereby reducing taxable income and minimising tax liabilities.
There are two main types of depreciation deductions for property investors: capital works and plant and equipment depreciation.
Plant and Equipment
Also known as Division 40, “plant and equipment” refers to the fixtures and fittings within the building. These are generally considered easily removable assets and include items such as carpets and air conditioning units.
Capital Works
Capital works rental property, also known as Division 43, allows investors to claim tax savings related to home renovations by deducting the costs of structural components like concrete and brickwork.
Capital Works also provides property investment tax deductions in Australia, enabling investors to claim deductions for the wear and tear of their properties.
Also referred to by the ATO as Division 43, this category covers income tax deductions that investors can claim from the wear and tear of a property’s structural components.
What Is a Capital Works Deduction?
As previously mentioned, Division 43 deductions are income tax deductions that investors can claim for the wear and tear of a property’s structural components and items permanently fixed to the property.
The expenses incurred from any structural improvements made to your investment property, such as adding an extra room, can also be claimed as capital allowances.
Who Can Claim a Capital Works Deduction?
Property investors who own properties for income-producing purposes are entitled to claim capital work deductions, provided they meet the eligibility criteria. In other words, tax depreciation deductions are available for both residential investment properties and commercial buildings.
How Are Capital Works Deductions Calculated?
The percentage rate at which a building depreciates depends on when construction commenced and its intended use, which affects the tax deduction you can claim. Accurate documentation of the construction cost is necessary for claiming tax deductions related to property investments.
Property investors who own residential properties built after September 15, 1987, can claim a capital works deduction at a rate of 2.5% per year over 40 years.
For structural improvements made to residential properties after February 27, 1992, you can claim capital works deductions on the actual construction costs at a rate of 2.5% per year for 40 years from the date of construction completion.
For a commercial rental property, the rate of capital works deduction can be either 2.5% or 4% per year, depending on factors such as when construction commenced, the type of capital works, and their intended use.
Duo Tax has developed an easy guide to understanding property types and their applicable:
| Construction Year | 21 Aug 1979 | 20 July 1982 | 22 Aug 1984 | 18 July 1985 | 16 Sept 1987 | 27 Feb 1992 to Present | |
|---|---|---|---|---|---|---|---|
| Structural Improvements | 2.5% | ||||||
| Residential | 4% | 2.5% | |||||
| Offices, Warehouses & other Commercial | 2.5% | 4% | 2.5% | ||||
| Manufacturing | 2.5% | 4% | 2.5% | 4% | |||
| Hotels, Motels & Guest Houses | 2.5% | 4% | 2.5% | 4% | |||
| Key: | 2.5% | 4% |
|---|
Example 1:
In January 2020, Carla purchased her first investment property for $410,000 and immediately rented it out.
Based on a report that she obtained from a Quantity Surveyor, the construction of the property commenced in January 2005 and was completed in October 2005. The cost of construction was estimated to be $290,000.
To determine the capital works deduction that she can claim in her tax return, she must use a depreciation rate of 2.5% as the construction of her residential property commenced after September 15, 1987.
The calculation is as follows:
$290,000 x 2.5% = $7,250
Carla rented out her property from January 1 to April 30, 2020, so she can only claim a deduction for 121 days of the year:
$7,250 x (121 days, 366 days in 2020) = $2,397
So, Carla can claim a capital works deduction of $2,397 in her 2019-2020 tax return.
To determine the capital works deduction that Carla can claim in her 2020-21 tax return, the calculation is as follows:
$290,000 x 2.5% = $7,250
Carla rented out her property for a full year to her new tenants, so she can claim for the full 365 days a year:
$7,250 x (365 365) = $7,250
As the property was built in 2005, Carla can continue claiming capital works deductions until 2045, provided that she still owns the property and it’s being used to produce income.
What Assets Qualify for a Capital Works Deduction?
The following table provides a comprehensive list of assets that can be claimed under capital works for both residential and commercial properties:
| Residential Property | Commercial Property |
| Bricks and mortar | Car Parking Space |
| Walls | Steel-framing of warehouse |
| Flooring | Built-in workstations |
| Electrical wiring | Glass partitions |
| Doors and door attachments (i.e. handles and locks) | Kitchenette |
| Sinks and basins | Shelving |
| Fences | Sinks and basins |
| Retaining walls | Down Pipe |
| Baths and showers | Flooring |
| Toilet bowls | Paint |
| Driveways | Roofing |
| Built-in wardrobes | Mezzanines |
| Concrete slabs | Bricks and Mortar |
| Timber Framing | Ducting for air conditioning |
| Paint | |
| Roofing |
Capital Works Deductions on Structural Improvements
Property investors can claim the following construction expenses under a capital works tax deduction:
- Building extensions, such as adding a room or a deck
- Altering a building, such as adding or removing an internal wall
- Structural improvements, such as adding a carport or retaining wall
Note:* Expenses incurred before construction, such as architect fees, engineering fees, quantity surveyor fees, and building permits, all form part of the construction expenditure and can be claimed as a capital works deduction.*
Capital Works That Don’t Qualify for Income Tax Deductions
Certain works that may seem like capital work in nature may not qualify for a tax deduction. Examples include:
- Excavation and demolition of a tree on a block of land with no intended purpose to build over it
- Excavation costs for the installation of softscape features like plants and turfing, as these are non-perishable items
- Costs of plants and turfing cannot be depreciated; however, pots and retaining walls are permissible capital works item
Record Keeping and Compliance for Depreciation Deductions
Maintaining accurate and detailed records is crucial to ensure compliance with the Australian Taxation Office (ATO) and maximise your depreciation deductions. Property investors should diligently keep records of all construction costs, including invoices and receipts, as well as the construction and completion dates.
Additionally, details of any structural improvements and renovations should be meticulously documented.
A comprehensive quantity surveyor report and a detailed depreciation schedule are also essential. These documents will help you accurately calculate your depreciation deductions and support your claims in the event of an ATO audit. Keeping all tax returns and supporting documentation organised will further ensure compliance with tax laws and regulations.
Benefits of Claiming Capital Works Deductions
Claiming capital works deductions can provide significant tax benefits for property investors. One of the primary advantages is the reduction of taxable income. By claiming depreciation deductions, property investors can lower their taxable income, reducing their tax liabilities. This can result in substantial tax savings over time.
Another key benefit is the increase in cash flow. Claiming capital works deductions means property investors can free up cash that can be used to offset loan repayments, cover property-related expenses, or even invest in other assets. This improved cash flow can make managing an investment property much more manageable and financially rewarding.
Maximising depreciation deductions also enhances the return on investment. By reducing tax liabilities and increasing cash flow, property investors can improve the overall profitability of their investment property. Additionally, claiming these deductions helps build property equity, which can be leveraged for securing future loans or investments.
The benefits of claiming capital works deductions are multifaceted, providing property investors with financial advantages that can significantly enhance their investment strategy.
Common Mistakes to Avoid
When claiming capital works deductions, property investors should be aware of common mistakes that can hinder their ability to maximise tax savings. One of the most frequent errors is failing to keep accurate records. Inadequate record-keeping can lead to incorrect or incomplete claims, resulting in missed opportunities for tax savings.
Another common mistake is incorrectly calculating depreciation. Property investors must ensure that they accurately calculate their depreciation deductions, considering the correct rates and dates of construction. Miscalculations can lead to over-claiming or under-claiming deductions, which can have financial repercussions.
Claiming deductions for ineligible assets is another pitfall to avoid. Property investors should only claim deductions for eligible assets, such as structural improvements and fixed items, and not for ineligible assets like land, plant, and equipment. Understanding the distinction between these categories is crucial for accurate claims.
Lastly, failing to seek professional advice can be a costly mistake. Property investors should consult with a qualified quantity surveyor or tax accountant to ensure they maximise their depreciation deductions and comply with tax laws and regulations. Professional advice can provide valuable insights and help avoid common pitfalls, ensuring property investors maximise their tax benefits.
By being aware of these common mistakes and taking proactive steps to avoid them, property investors can confidently claim their capital works deductions and maximise their tax savings.
Key Takeaways
As a property investor, understanding how to maximise tax depreciation deductions is crucial for getting the most out of your investment property. Capital works deductions are claimable on the depreciation of the structural elements of a building and the fixed items within the property. You can also claim construction costs for improvements or alterations to your income-producing property.
Depreciation on your investment property is a significant tax-deductible expense. To maximise the benefits available to you, the deductions for the depreciation of your investment property must be accurately assessed by an independent, qualified person, such as an expert quantity surveyor who specialises in tax depreciation.
At Duo Tax, our Quantity Surveyors are not only the very best agents but, most importantly, a team of avid property investors keen to help other property investors save thousands of tax dollars every year.
To see if you qualify for capital works deductions or to request a sample report, contact us today!
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Tuan is an award winning Quantity Surveyor and leads Duo Tax Quantity Surveyors – Australia’s fastest growing provider of Tax Depreciation.
