Understanding Tax Depreciation: A Key to Property Investment Success
When purchasing an investment property, it’s important to consider all aspects of the investment, including tax implications. One such consideration is tax depreciation, which can significantly impact the return on investment. In order to claim tax depreciation, property investors need to obtain a detailed inventory of the assets in the investment property, including their value and expected lifespan. This is commonly known as a depreciation report.
By understanding the report, property investors can claim tax deductions for the decrease in value of the building and its fixtures and fittings, which can increase their cash flow and improve their return on investment. Keep reading to know what tax depreciation is, how it works, and how it can be a key to property investment success.
What is Tax Depreciation?
Tax depreciation is the decrease in an asset’s value over time caused by wear and tear, obsolescence, or other factors. In the context of property investment, tax depreciation refers to the decrease in the value of the building and its fixtures and fittings. This decrease in value is a tax deduction that property investors can claim against their taxable income. By claiming tax depreciation, investors can reduce their taxable income and pay less tax, increasing their cash flow and improving their return on investment.
How Does Tax Depreciation Work?
To claim tax depreciation, property investors need to obtain a depreciation report. It is a detailed inventory of the assets in the investment property, including their value and expected lifespan. A qualified quantity surveyor prepares the report and outlines the tax deductions that the investor can claim over the life of the property.
The two types of tax depreciation that property investors can claim are capital works deductions and plant and equipment deductions. Capital works deductions refer to the decrease in value of the building and its structural components, such as walls, floors, and roofs. Plant and equipment deductions refer to the decrease in value of the removable assets in the property, such as air conditioning units, carpets, and appliances.
Capital works deductions are claimed over the life of the building, which is typically 40 years for residential properties and 25 years for commercial properties. Deductions for plant and equipment are claimed throughout the lifespan of each asset, which can vary from 6 to 20 years, depending on the type of asset being used.
Why is Tax Depreciation Important for Property Investment Success?
Tax depreciation can have a significant impact on the return on investment for property investors. Investors can reduce their taxable income and pay less tax by claiming tax deductions for the decrease in value of the building and its fixtures and fittings. This can increase their cash flow and improve their return on investment.
For instance, let’s say an investor purchases a residential property for $500,000. The depreciation report identifies $100,000 worth of fixtures and fittings that can be claimed for plant and equipment deductions over the next ten years. The investor’s taxable income is $100,000 annually, and they are in the 37% tax bracket. By claiming the plant and equipment deductions, the investor can reduce their taxable income to $63,000 per year, which reduces their tax bill by $14,800 per year. Over ten years, the investor will save $148,000 in tax, which increases their return on investment from 5% to 7%.
In addition to increasing cash flow and improving return on investment, tax depreciation can help property investors better manage their cash flow. By reducing their tax bill, investors can allocate more funds to other investment areas, such as maintenance, repairs, or renovations.
In essence, tax depreciation plays a vital role in property investment success, and investors who understand and utilize it to their advantage can reap the benefits. By implementing tax depreciation strategies, property investors can maximize their cash flow, reduce their tax liability, and improve their return on investment, ultimately leading to greater financial stability and success in the long term.