When finishing your end-of-financial-year accounts, an accountant simply uses those depreciation amounts as deductible costs under the relevant sections, Division 43 Capital Works or Division 40 Depreciating Assets.
The result is a decrease in net profit, which lowers the owner's tax liability. In certain circumstances, a depreciation schedule is a one-time investment that may be utilised for years. It commonly reflects depreciation deductions for up to 40 years.
Eligibility to Make a Commercial Property Depreciation Claim
Any capital works (Division 43 works) that commercial property owners have paid for are eligible to claim depreciation on.
These works often include the original structure and its built-in extensions. It also covers later works, which may include the addition or renovation of an area such as a bathroom, kitchen or outdoor space.
Commercial property owners are also eligible to claim depreciation on any plant and equipment assets (Division 40 assets) that they have purchased, if it is included in the lease agreement.
Tenants can also make a claim for commercial property depreciation if they paid for fit-outs inside the building.
As well as fit-outs, this could cover claims for furniture, machinery and electrical systems that they own as part of their company.
For example, a company that operates a hospital or office setting is likely to submit claims for carpeting, window treatments, reception desks, furnishings, medical equipment and the like. A proprietor of a café or restaurant, for instance, may claim depreciation on an interior fit-out, fridges, a bar and counter, tables and seats.
While most commercial property depreciation deductions will likely apply to Division 40 plant and equipment assets, when structural, certain works may qualify as Division 43 capital works depreciation deductions.
Calculating How Much Depreciation You Are Entitled To
How commercial property depreciation is calculated will vary from one building to another.
Commercial property is divided into different categories based on its intended use, and the ATO has established guidelines for commercial property depreciation for each category.
The qualifying period, the effective lifetime of the building, and other factors will determine the final rate of depreciation for the building and assets.
Each of these components is dealt with separately: The actual property building comes under Division 43, while the assets associated with the building are usually covered by Division 40. Assets under Division 40 and 43 use different methods to calculate their respective rates of depreciation.
As an overall summary, while either type can be depreciated using the Prime Cost approach, Division 40 assets have the option to use the Diminishing Value approach instead.
This is because, during the course of their useful lives, Division 40 assets can be placed into low-value pools, so it makes sense to enable maximum depreciation deductions early on in their useful lives.
Division 43 (Capital Works) Depreciation
The structure of the commercial investment property building uses the prime cost method to calculate the rate of depreciation.
For commercial property depreciation deductions, the capital works or actual structure of an investment property is referred to as Division 43. This covers all tools and supplies needed in construction as well as permanent fixtures such as sinks and countertops.
The prime cost method is used to calculate depreciation for all of these types of assets. This approach makes the assumption that the decline in the value of a deteriorating asset is consistent across its useful life.
It is crucial to understand that commercial property depreciation is determined by using the cost of construction. This is independent of the purchase price or appraisal of the property. As such, a quantity surveyor will be needed to accurately determine the construction costs of a given commercial property.
Division 40 (Plant and Equipment) Depreciation
To claim depreciation deductions, plant and equipment can be calculated using either the Prime Cost or Diminishing Value methods.
The ATO has established the effective lifetime of each asset covered under this section, including industry-specific assets. In fact, an exhaustive list of the nominated effective lifetimes for assets across industry classes, known as TR 2018/4, has been provided by the ATO.
The effective lifetimes of commercial property are different to that of residential property depreciation. For example, a carpet in a hotel room is expected to age more quickly than that in an office building, which may still age more rapidly than that in a family home.
Assets under Division 40 may use the Prime Cost method, under which the yearly tax deduction is constant each year.
Alternatively, they may use the Diminishing Value method, which means that the value of a depreciating asset falls more in the early years of its useful life and less in the later years. This front-loads the tax deduction towards the beginning of the useful life of the asset.
Rely on the Expert Help of a Quantity Surveyor
A competent quantity surveyor will be able to apply the appropriate rates to the depreciation schedule of a commercial property. With their expert consultation, you can determine both the Prime Cost and Diminishing Value depreciation schedules during the lifetime of an asset.
A quantity surveyor is an expert in understanding the depreciation of a commercial property. For example, assets that are pooled together, based on their cheap cost and low worth, may depreciate more quickly.
In order to maximise deduction claims during certain years, a high-quality depreciation schedule from a competent quantity surveyor can guarantee that assets are put to low-value pooling in the right years.
Sometimes not using pooling options is preferable for a commercial property investor. If so, a timetable for capital claims can be used to turn this off.
Unless the values are specified in the contract of sale, a quantity surveyor can even revalue specific assets at the time of acquisition. They can also assign new effective lifetimes based on their professional judgement.
When to Obtain a Schedule for a Commercial Property
At the Point of Acquisition
Buying and coming into the ownership of a commercial property is the perfect time to get the depreciation schedule for it.
You will require a quantity surveyor to determine the building's construction cost historically and project your depreciation deductions for the remaining effective life. This is because commercial property depreciation is determined by the building's construction cost and is not based on the purchase price or valuation.
The ATO does not view accountants as qualified to estimate construction expenses.
A depreciation schedule may already be included in the sale, courtesy of the vendor. It is advisable to conduct your own depreciation plan, to maximise the depreciation deductions that are available to you.
However, if you prefer to keep the plan that was supplied, it would be prudent to make sure that the tax depreciation schedule was created by a qualified quantity surveyor. Otherwise, it may not comply with ATO requirements.
At Renovation or Refurbishment
To maximise the depreciation deductions available to the commercial property, your commercial property depreciation schedule should be modified whenever structural changes or additions (capital works) are made. Landscaping and the rewiring or replacement of the electrical or plumbing systems are a few examples of structural works.
Commercial property owners should also have their tax depreciation schedule updated to reflect any upgrades or updates to the plant and equipment assets. Common changes include upgrading the air conditioning units, adding security systems, the installation of hot water, and installing flooring or carpets.
To claim depreciation deductions, it’s key to make sure you have a reliable and current tax depreciation schedule, before the renovations go underway and assets are removed or destroyed. Because any assets that are lost still have some inherent worth attached to them, in the year of their disposal, the entire residual value of the assets can be deducted.
For instance, the complete renovation of the bathrooms would involve ripping out the plumbing and electrical systems as well as the tile work. As these assets still have thousands of dollars of residual value when they are disposed of, this can translate to thousands of dollars in depreciation deductions to be claimed in that year.
In Discussion of a New Lease
To claim depreciation deductions, you may need to adjust an existing tax depreciation schedule to reflect changes negotiated for a new lease.
For example, if you agree to supply a new tenant with certain furnishings or assets, this will need to be updated into the tax depreciation schedule – especially if these changes amount to significant restoration or refurbishment.
These are the kinds of nuances your quantity surveyor can help you navigate. Learn more about our services for tax depreciation Sydney, tax depreciation Melbourne and tax depreciation Brisbane, or order your property depreciation report.