All About Construction Fit-Out Depreciation Rates in Australia

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Tuan Duong

Let’s say you’re a tenant who has just invested in a new fit-out for your leased property. You’ve installed office partitioning, desks, and other fixtures to create an ideal workspace. On the other side of the coin, you’re a landlord who has just welcomed a tenant with a brand-new fit-out.

In both scenarios, the question arises: who gets to benefit from the depreciation of these new assets?

Various depreciation methods can be applied to these assets, such as straight-line or accelerated depreciation methods.

Understanding how to navigate these depreciation rates can be a game-changer. But how do you make sense of the rules around tenant asset depreciation? What happens when a fit-out is left behind? And what are the implications for landlords installing new fit-outs?

Here’s what you need to know.

What is a Construction Fit-Out?

Construction fit-out refers to the process of making interior spaces suitable for occupation. It’s often used within office developments, where the base construction is completed by the developer and the final fit-out by the tenant. 

The fit-out usually involves installing the necessities for specific operations, whether for an office, a retail store, or a restaurant.

Common elements in a fit-out can range from the basics like lighting, flooring, and partition walls to more specific installations like office cubicles, kitchen facilities, or even specialised machinery in an industrial setting.

Understanding Depreciation Expense in the Context of Construction Fit-Outs

Depreciation is the gradual decrease in the value of an asset over time. This decrease can be due to various factors, including wear and tear, age, or obsolescence. In the context of a construction fit-out, depreciation applies to the multiple elements installed in the property, such as lighting fixtures, partition walls, or flooring. Calculating the annual depreciation expense for these fit-out elements is essential for accurate financial reporting.

Accumulated depreciation is the total amount subtracted from the value of the fit-out elements over time.

Why is understanding depreciation important for property owners, tenants, and landlords?

Well, depreciation can have significant tax implications. The Australian Taxation Office (ATO) allows property owners to claim a tax deduction for the depreciation of their assets over time. 

This can lead to substantial tax savings, making it a key aspect of property investment to understand and manage effectively. Depreciation expense, calculated using various methods, affects financial statements and tax deductions.

However, navigating depreciation on a construction fit-out isn’t as straightforward as it seems.

And here’s why.

Understanding Depreciation in the Context of Construction Fit Outs

Tenant Asset Depreciation and Life of the Asset in Construction Fit-Out

Let’s consider a scenario where a tenant is installing a new fit-out. The tenant can claim depreciation on these depreciating assets, effectively reducing their taxable income. And if these assets meet specific criteria set by the ATO, the tenant can claim an immediate write-off.

This is known as an Instant Asset Write-Off and essentially allows a tenant to claim 100% of the asset’s value as a tax deduction in the year of acquisition rather than depreciating it over several years. This results in significant depreciation expenses that can be claimed for tax deductions.

Now, what happens if the tenant decides to leave the premises at the end of the lease or terminate the lease early?

If the lease contract requires the tenant to ‘make good’ – that is, return the premises to their original condition – they might choose to strip the premises of the fit-out they installed. In this case, they can claim the balance of the un-deducted values of the assets as an immediate write-off. This is because the assets are no longer being used for income-generating purposes.

However, if the tenant reuses the assets in a different setting or fit-out, the depreciation rules change slightly. The purchase and depreciation of fit-out elements are recorded in the asset account on the balance sheet, which is later adjusted through regular depreciation.

Let’s say, for example, they take a coffee machine from a cafeteria to another site. In this case, they can continue to depreciate the coffee machine, assuming it’s the same entity holding the asset. If there’s a change of ownership, new depreciation rates may need to be applied, as different legislation may apply depending on the year the asset was acquired.

What Happens When a Fit-Out is Left Behind?

When a tenant leaves behind a fit-out, ownership of the fit-out typically transfers to the landlord or new owner. Installations could include anything from office partitioning and desks to more specialised installations. The cumulative depreciation, which is the total depreciation expense incurred on the fit-out up to the point it is left behind, must be considered.

In such cases, the landlord or new owner can assess the remaining fit-out and depreciate it accordingly. 

In other words, they can claim a tax deduction for the decrease in value of these assets over time, potentially leading to significant tax savings. This is because the asset loses value quickly in the first few years of ownership due to ongoing use, wear and tear, and other factors.

The landlord or new owner also has the right to strip the fit-out and claim an immediate write-off if they wish. This decision could be strategic if, for example, they plan to renovate the property or install a new fit-out.

What Happens When a Fit-Out is Left Behind?

What are Construction Fit-Out Depreciation Rates?

In the context of a construction fit-out, the Australian Taxation Office (ATO) distinguishes between two types of depreciation: capital works and plant and equipment. An accelerated depreciation method, such as the diminishing value method, can be used to calculate depreciation more quickly.

For fit-out elements, the declining balance method applies a set percentage to the asset’s book value, resulting in larger depreciation in earlier years that declines each year after that.

A Bit About The Diminishing Value Method

The diminishing value method is a depreciation approach used in Australia that allows businesses to claim a higher percentage of an asset’s cost in the early years of its effective life. The deductible amount decreases each year until the asset’s value reaches zero.

A Bit About The Diminishing Value Method

The diminishing value method is a depreciation approach used in Australia that allows businesses to claim a higher percentage of an asset’s cost in the early years of its effective life. The deductible amount decreases each year until the asset’s value reaches zero.

The formula for calculating depreciation using the diminishing value method is:

Base value x (days held ÷ 365) x (200% ÷ asset’s effective life)

Note: The formula uses 150% instead of 200% for assets acquired before May 10, 2006.

The base value is the asset’s cost in the first year, and in the following years, it is the asset’s opening adjustable value plus any amount included in the asset’s second element of cost for that year.

This method is popular because it provides higher returns sooner, allowing investors to reduce debt faster or reinvest the additional return. It also uses low-cost and low-value pooling to increase claims on items under $1,000 and allows a 100% claim on items worth less than $300.

However, the diminishing value method cannot be used for certain assets such as in-house software, intellectual property (except copyright in a film), spectrum licences, datacasting transmitter licences, or telecommunications site access rights.

Capital Works Accumulated Depreciation

Capital works, also known as Division 43, refers to the building’s structure and items that are permanently fixed to the property. This could include walls, roofs, doors, kitchen cabinets, and even the construction of driveways and fences.

The depreciation rate for capital works is generally 2.5% per year over 40 years for properties where construction commenced after September 15, 1987.

Plant and Equipment Depreciation

Plant and equipment, or Division 40, refers to the property’s removable assets or mechanical fixtures. This could include appliances, carpets, blinds, and even assets like fire extinguishers and security systems. Units of production depreciation is a method for calculating depreciation based on the usage of plant and equipment.

The depreciation rates for plant and equipment assets are not uniform. They depend on the effective life of the fixed asset, as determined by the ATO. For example, a carpet might have an effective life of 10 years, while a dishwasher might have an effective life of 5 years.

The depreciation rate is calculated based on this effective life, using either the prime cost or diminishing value method.

In the prime cost method, the deduction for each year is calculated as a percentage of the cost. In the diminishing value method, the deduction is calculated as a percentage of the balance you have left to deduct.

Plant and Equipment Depreciation

The Role of a Quantity Surveyor in Determining the Depreciation Schedule

A Quantity Surveyor is a professional who specialises in estimating and managing costs in construction and building projects, including calculating depreciation rates for construction fit-outs. 

They have the expertise to identify all the depreciable assets in a fit-out, estimate their value, and calculate their effective life, which is the period over which an asset can be depreciated.

Quantity Surveyors play a key role in ensuring that you claim the maximum allowable depreciation deductions on your fit-out. They can provide a detailed depreciation schedule, which outlines the depreciation claims you can make each year. 

A tax depreciation schedule can be valuable in managing your tax obligations and optimising your financial outcomes.

Key Takeaways 

  • Construction fit-out refers to the process of making interior spaces suitable for occupation and includes various elements like lighting, flooring, and partition walls.
  • Depreciation is essential for accurate financial reporting and can result in substantial tax savings for property owners, tenants, and landlords.
  • Different depreciation methods, such as straight-line and accelerated depreciation, can be applied to fit-out assets.
  • Tenants can claim depreciation on fit-out assets, with the possibility of an immediate write-off under certain criteria.
  • If a tenant leaves the premises or terminates the lease, they may have options to claim the remaining un-deducted values of the fit-out assets.
  • Ownership of the fit-out typically transfers to the landlord or new owner when a tenant leaves it behind, and they are entitled to assess and depreciate it accordingly.
  • Remember, every fit-out is unique, and the depreciation rules can vary depending on a range of factors. Therefore, seeking professional advice tailored to your specific circumstances is always advisable.

If you’re looking for expert guidance on construction fit-out depreciation, our team is here to help. We offer a range of services to help you navigate the complexities of depreciation and optimise your financial outcomes. 

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Disclaimer: Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal or tax advice. You should, where necessary, seek a second professional opinion for any legal or tax issues raised in your investing affairs.

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Tuan Duong

Tuan is an award winning Quantity Surveyor and leads Duo Tax Quantity Surveyors – Australia’s fastest growing provider of Tax Depreciation.

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