In 2017, the Australian Federal Budget introduced a pivotal change affecting depreciation claims on residential investment properties. Specifically, from 7:30 pm AEST on 9 May 2017, investors who purchase second-hand residential properties can no longer claim Division 40 depreciation deductions for previously used plant and equipment. This adjustment was aimed at limiting depreciation deductions to only the actual economic life of the asset, preventing investors from claiming depreciation on assets that have already been used by previous owners.
Under Division 40 of ITAA 1997, plant and equipment refers to items such as air conditioners, carpets, and appliances. The 2017 budget changes mean that if these items were previously used, their depreciation cannot be claimed by the new owner. However, pre-existing owners of properties, who purchased before the cut-off time, are grandfathered under the old rules and can continue to claim depreciation as before.
A common misconception is that these changes eliminate all depreciation benefits. However, Division 43 deductions, which pertain to the building's structural elements and fixed assets, remain unaffected. Accountants must now place a greater emphasis on these deductions when advising clients on investment properties purchased post-2017.
To see how this plays out, consider a 2010-built 2-bedroom apartment in Southbank, Melbourne, purchased for $750,000 in 2018. Under the new rules, the investor cannot claim depreciation on the pre-existing air conditioning unit or oven. However, they can still claim Division 43 deductions on the building structure, which could be approximately $5,000 annually. With a 37% marginal tax rate, this results in a tax saving of around $1,850 each year, highlighting the importance of maximising capital works deductions.
In our experience reviewing thousands of properties across Australia, many investors initially overlook the potential of Division 43 deductions. Additionally, investors often misunderstand the grandfathering provisions, thinking they apply to new acquisitions. Another frequent oversight is failing to adjust investment strategies to account for the reduced depreciation benefits, which can affect the overall return on investment.
The answer can differ depending on your situation. For instance, properties acquired before 9 May 2017 retain the ability to claim Division 40 deductions. Commercial properties are unaffected by these changes, as they are exempt from the 2017 budget adjustments. Furthermore, properties held within a self-managed super fund (SMSF) may have different implications, particularly regarding asset ownership and depreciation strategies.
Engaging a Chartered Quantity Surveyor alongside an accountant is crucial for navigating these complexities. A QS can provide a detailed depreciation schedule that highlights Division 43 opportunities, while an accountant can ensure these align with the client's broader tax strategy.