Scrapping old assets before renovating can be a strategic move to save on taxes, yet it's a concept often overlooked or misunderstood by property investors. By understanding how scrapping works under Division 40 of ITAA 1997, you can make informed decisions that potentially lower your taxable income.
When you scrap an asset, you are essentially writing off its remaining undepreciated value. This means that if you've been claiming depreciation on an asset, such as a kitchen or air conditioning unit, and you decide to dispose of it during a renovation, you can claim the remaining value as an immediate deduction. This is particularly beneficial if the asset has not yet been fully depreciated.
The most common misconception about scrapping is that it only applies to large-scale renovations. In reality, even small updates can involve the removal of depreciable assets, and these can be scrapped to enhance your tax position. It's important to note, however, that the 2017 budget changes restrict deductions on second-hand residential properties acquired after 9 May 2017. This affects the ability to claim Division 40 deductions on previously used plant and equipment.
Take a practical example of a 2009-built 2-bedroom apartment in Fortitude Valley, Brisbane, purchased for $750,000. Suppose you decide to renovate the kitchen, replacing all appliances and cabinetry. The remaining undepreciated value of these assets is $15,000. By scrapping them, you can claim this amount as an immediate deduction. If you're in the 37% tax bracket, this scrapping could reduce your tax liability by $5,550 in the year you undertake the renovation.
In our experience reviewing thousands of properties across Australia, many investors miss the opportunity to maximise deductions through scrapping. They often underestimate the value of assets being removed or fail to consult a qualified Quantity Surveyor (QS) to ascertain the correct undepreciated values. Additionally, some investors assume all assets can be scrapped, not realising that the rules differ for properties acquired after the 2017 legislative changes.
The answer can differ depending on your situation. If you acquired a second-hand residential property post-9 May 2017, the ability to claim scrapping on plant and equipment is limited. However, scrapping can still apply to capital works for properties built after 1987. For commercial properties, scrapping rules are more lenient, allowing broader deductions. The ownership structure, such as SMSF or joint ownership, can also influence your eligibility and the benefits you receive.
Given the complexity and potential financial impact, it's crucial to consult with both a Chartered Quantity Surveyor and your accountant. A QS can accurately assess the undepreciated values and ensure compliance with ATO guidelines, while your accountant will integrate these deductions into your overall tax strategy.