We are often asked "what items can you claim a full deduction for, and what items are 'depreciated'."
Basically, an 'Expense' is something that may be entitled to an immediate deduction in the income year you incur the expense. A 'Capital Works Deduction' is an expense of a capital nature that is depreciated over time and/or may form part of the cost base of the property for capital gains tax purposes.
What is an EXPENSE?
An expense can be classified as any of these things:
- advertising for tenants
- bank charges
- body corporate fees and charges
- cleaning costs
- council rates
- electricity and gas
- gardening and lawn mowing
- in-house audio and video service charges
- insurance (building, contents, public liability)
- interest on loans
- land tax
- lease document expenses (preparation, registration, stamp duty)
- legal expenses (excluding acquisition costs and borrowing costs)
- mortgage discharge expenses
- pest control
- property agents fees and commissions
- quantity surveyor's fees
- secretarial and bookkeeping fees
- security patrol fees
- servicing costs, for example, servicing a water heater
- stationery and postage
- telephone calls and rental
- tax-related expenses
- travel and car expenses (for rent collection, inspection of property, maintenance of property)
- water consumption and supply charges
- repairs and maintenance*
* Repairs and maintenance is the most commonly asked item. Expenditure for repairs made to the property may be deductible, however, these repairs must relate directly to wear and tear or other damage that occurred as a result of your renting out the property. Repairs generally involve a replacement or renewal of a worn-out or broken parts, for example, replacing damaged guttering due to a storm or replacing part of a damaged fence due to a fallen branch.
Repairs carried out to a newly purchased property though, are NOT expenses, and are deemed as Capital Works. Feel free to refer to the examples below:
ATO Example on 'repairs prior to renting out a property'
"The Hitchmans needed to do some repairs to their newly acquired rental property before the first tenants moved in. They paid an interior decorator to repaint dirty walls, replace broken light fittings and repair doors on two bedrooms. They also discovered white ants in some of the floorboards. This required white ant treatment and replacement of some of the boards. These expenses were incurred to make the property suitable for rental and did not arise from the Hitchmans' use of the property to generate assessable rental income. The expenses are capital in nature and the Hitchmans are NOT able to claim a deduction for these expenses."
ATO Example on 'repairs when the property is no longer rented out'
"After the last tenants moved out in September 2013, the Hitchman's discovered that the stove did not work, kitchen tiles were cracked and the toilet window was broken. They also discovered a hole in a bedroom wall that had been covered with a poster. In October 2013 the Hitchman's paid for this damage to be repaired so they could sell the property. As the tenants were no longer in the property, the Hitchman's were not using the property to produce assessable income. However, they could still claim a deduction for repairs to the property because the repairs related to the period when their tenants were living in the property and the repairs were completed before the end of the income year in which the property ceased to be used to produce income."
What is a CAPITAL WORKS DEDUCTION?
A Capital Works Deduction refers to the replacement of an entire structure or unit of property (such as a complete fence or building, a stove, kitchen cupboards or refrigerator)
In other words, they are improvements, renovations, extensions and alterations, or
initial repairs, to remedy defects, damage or deterioration that existed at the date you acquired the property.
How are these deductions calculated?
This is where things get complicated and where the benefits of having a professional 'Tax Depreciation Schedule' prepared by a quantity surveyor such as BMT is invaluable. We've had experiences where our landlords were able to claim thousands of dollars' worth of extra deductions by having this schedule and we highly recommend it.
There are two methods to work out your deduction, both of which are based on the effective life of the asset (which is determined by ATO ruling TR2014/4).
- The 'Diminishing Value' method is most commonly used and assumes that the decline in value each year is a constant proportion of the remaining value and produces a progressively smaller decline over time (allowing higher deductions immediately).
- The 'Prime Cost Method' assumes that the value of a depreciating asset decreases uniformly over its effective life (meaning smaller claims up front, which is why it is not as popular.) The decline in value calculator on the ATO website will help you with the choice and the calculation.
For more information, view the full Guide for Rental Property Owners from the ATO.