Residential rental properties: Depreciation deductions

The circumstances under which owners of residential rental properties will be able to claim deductions for the decline in value of certain plant and equipment changed following an announcement made in the Federal Budget on 9 May 2017, which will deny depreciation deductions on plant and equipment acquired from a previous owner of the property effective from 1 July 2017.

Where depreciation deductions can be claimed on depreciating assets used in the course of deriving rental income from residential properties they will be claimed under Division 40 of the Income Tax Assessment Act 1997 (the ITAA 1997) which for additions acquired during the year ended 30 June 2017 will be based on the effective lives of such assets as set out under Taxation Ruling TR 2016/1.

Each of these matters is separately discussed below.

2017-18 Federal Budget announcement

From 1 July 2017, the Federal Government proposes to limit the depreciation of plant and equipment used in rental properties to outlays actually incurred by investors who own residential real estate properties.

Under the proposed arrangements, investors who purchase plant and equipment for a residential investment property after 9 May 2017 will be able to claim a deduction for the depreciation of such plant and equipment over their effective life.

However, subsequent owners of the property will be unable to claim deductions for plant and equipment purchased by the previous owner of that property. The cost incurred by subsequent purchasers in acquiring such depreciating assets will instead be taken into account for CGT purposes when the property is on sold (although the specific mechanics of how those amounts will be included in the cost base of an asset are not detailed in the 2017-18 Federal Budget announcement).

As a transitional measure where plant and equipment forms part of a residential property on 9 May 2017 (or the property was acquired under a contract for a property entered into by 7.30 p.m. of that date), the existing depreciation rules will continue until the property is either sold or the asset is written off. This would appear to allow the purchaser of a pre-10 May 2017 acquired rental property to claim depreciation on depreciating assets which were previously acquired by a former owner of that rental property.

Rental property owners and their advisers should closely monitor how these proposed changes are legislated to ensure that any depreciation of rental property plant and equipment is correctly calculated.

Calculating effective life of residential rental property assets

As an owner of a residential rental property is not regarded as carrying on a business it cannot rely on the concessional depreciation rates available under the small business entity capital allowance rules under Subdivision 328-D of the ITAA 1997. Accordingly, it is necessary to apply the general capital allowance rules under Division 40 of the ITAA 1997 in calculating the decline in value of rental property plant and equipment.

Broadly, whilst such a taxpayer will be able to claim an immediate deduction for a depreciating asset costing $300 or less if the asset is used predominantly to derive rental income generally reference must be made to the Commissioner of Taxation’s estimate of effective lives under section 40-95(1) of the ITAA 1997 in depreciating assets whose cost is more than $300.

Current ATO effective life of depreciating assets under Taxation Ruling TR 2016/1.

The Australian Taxation Office (ATO) annually reviews its determination of the effective lives of depreciating assets, including plant included in residential rental properties, with the most recently published effective lives being reflected in Taxation Ruling TR 2016/1.

This ruling provides taxpayers with, amongst other things, a comprehensive guide to the effective lives of depreciable assets typically contained in residential rental properties.

The effective life of an asset forms the basis of the prime cost depreciation rate, as it reflects the term over which the asset is to be written-off in equal proportionate instalments. To obtain an accelerated rate of depreciation assets can be alternatively written off at a diminishing value rate which for depreciating assets acquired after 9 May 2006 is 200% of the prime cost rate (instead of the previous 150% diminishing value rate for assets acquired before that date).

What does the Ruling say?

Table A and Table B in Taxation Ruling TR 2016/1 outline the ATO’s view on the effective lives of various depreciating assets.

Table A contains categories of assets under industry headings and may only be used by members of the specified industry. The amendments to Table A relate to, amongst other things, residential rental property assets. Where Table A does not apply to a particular depreciating asset, reference should be made to the list of effective lives that apply to depreciating assets generally which is set out under Table B.

It should be noted that residential property includes houses, units or flats commonly used as residential properties. The effective lives of depreciating assets held by residential property operators listed in Table A does not, therefore, cover assets generally found in commercial, industrial or retail properties. For these assets, it is necessary to refer to other categories of industries listed in Table A which refer to depreciating assets (e.g. the effective lives of certain commercial and office building assets listed in relation to non-residential property owners). If it is not possible to identify the effective life of particular assets under Table A the general rates listed under Table B must be applied, unless a choice is made to self-assess the effective lives of the relevant assets.

Table A – Industry Specific Effective Lives

Taxation Ruling TR 2016/1 contains a comprehensive list of the effective lives of various assets typically contained in residential rental properties. Some of the assets contained in the ruling include:

Asset

Effective Life

Prime Cost

Diminishing Value (for assets acquired after 9 May 2006)

Automatic garage door control 5 20% 40%
Automatic garage door motor 10 10% 20%
Carpets 10 10% 20%
Ceiling fans 5 20% 40%
Cook tops and range hoods 12 8.33% 16.67%
Dishwashers 10 10% 20%
Ducted heaters – gas 20 5% 10%
Fire alarms 6 16.67% 33.33%
Light fittings 5 20% 40%
Fire extinguishers 15 6.67% 13.33%
Fire hoses and nozzles 10 10% 20%
Hot water units – electric/gas 12 8.33% 16.67%
Hot water units – solar 15 6.67% 13.33
Ovens 12 8.33% 16.67%
Refrigerators 12 8.33% 16.67%
Washing machines 10 10% 20%

A comprehensive list of assets and effective lives are available in TR 2016/1: Income tax: effective life of depreciating assets (applicable from 1 July 2016).

Self-assessment of effective life

As already is the case, a taxpayer can choose to use the ATO’s determination of the effective life of a depreciating asset or self-assess the effective life in accordance with section 40-105 of the ITAA 1997.

Taxpayers choosing to self-assess the effective life of an asset must remember that their self-assessment determination may be subject to ATO review. As such, the advantage in using the ATO’s determination of the effective life of a depreciating asset is that the ATO’s rate represents a ‘safe harbour’ rate that will not be challenged in any audit process undertaken by the ATO.

Where a taxpayer chooses to self-assess an effective life rate that is different to that outlined by the ATO, the taxpayer will be required to have sufficient evidence to demonstrate why the ATO’s effective life rates are not appropriate in the particular circumstances.

If you would like to discuss any matters in relation to the above changes in respect to your particular circumstances, please do not hesitate to contact us.

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