If your SMSF clients are thinking about or have invested in property, they need to know how to save tax by claiming a depreciation deduction. Calculating depreciation on a property can be complex, so generally, in order to claim each year, they will need a tax depreciation report.
What is depreciation?
An SMSF generally cannot claim an instant deduction for the purchase of capital assets. Rather than claiming a deduction for the cost of the asset in the year of purchaset, an SMSF claims the deduction over a number of years. A depreciating asset such as a building or building fixtures are assumed to have an effective life and decline in value over time and the amount and when an SMSF can claim and amount each year will depend on its effective life.
Types of Property Depreciating Assets
There are generally two types of depreciating assets that an SMSF can claim – capital works and plant and equipment.
Capital works (Division 43)
Capital works are the historical cost of constructing the building including initial building or extension of the building itself, construction of driveways or fences or Improvements to leased buildings. Considering the effective life of the asset, the depreciation is claimed over an extended period of time, usually 40 years but in some cases 25 years. This will depend on when the building was constructed. To find out which is applicable read more on the ATO’s website here – https://www.ato.gov.au/business/depreciation-and-capital-expenses-and-allowances/capital-works-deductions/
To be eligible to claim this deduction an SMSF must have:
details of the type of construction
the date construction commenced
the date construction was completed
the construction cost (not the purchase price)
details of who carried out the construction work
details of the period during the year that the property was used for income producing purposes.
In some circumstances an SMSF may be able to use an estimate to determine the cost price if it cannot get hold of the above information.
Plant and Equipment Items (Division 40)
Plant and Equipment items are those items that are easily removable from the property. As with the building, each item has an effective life that can be used to determine how much depreciation can be claimed each year. There are two methods that can be used. Prime cost method is where the claim amount is the same each year over the effective life or the more popular diminishing cost method where more of the depreciation is claimed in the earlier years of its effective life.
In a residential property, the most common plant assets are:
Hot Water Systems
Carpets
Blinds
Air Conditioners
Eligible plant and equipment items with a cost of $300 or less qualify for an immediate full deduction in the year that they are purchased.
How Does an SMSF claim Depreciation?
If your SMSF clients want to claim depreciation, they will you will also need to put together a formal depreciation schedule. This sets out every depreciating asset in your SMSF property. An SMSF Trustee could put this together but that would be a time-consuming exercise that they could easily get wrong. Most SMSF Trustees would not even consider taking this task on and so helping them engage a Quantity Surveyor to prepare a Tax Depreciation Report makes sense.
What is a Tax Depreciation Report
A Tax Depreciation Report sets out the depreciation entitlements available to your SMSF clientMost properties can have a tax depreciation report and a Quantity Surveyor can help you work with your client to determine if it is cost effective for their particular property. A Quantity Surveyor prepares the Tax Depreciation Report and they are one of only a few professionals that the ATO will allow to estimate construction costs. Tax Depreciation Reports should include:
40-year forecast illustrating all depreciable items
Both prime cost and diminishing value methods of depreciation
The effective life and depreciation rate for all division 40 (plant and equipment) assets
Low value and small business entity pools and instant asset write-off
Generally, the ATO lets property investors deduct the cost of depreciation from their overall income. This means, as a property investor, your SMSF clients can be enjoying significant tax savings at the same time as their property investment grows.
Benefits of obtaining a Tax Depreciation Report
The cashflow benefits can be significant. So much so that the tax benefits your SMSF clients can get from obtaining a report may be the difference between a positive or negative return and they can be used by a mortgage broker to determine borrowing capacity for a Limited Recourse Borrowing Arrangement (LRBA). These tax savings can be re-invested through to retirement.
An often-overlooked report that can save your SMSF clients time and money, a Tax Depreciation Report is well worth your time and investment to ensure that your SMSF clients do not miss deductions.
At Keep It Simple Super we work with all of our partners to help them provide simple solutions and outcomes for their SMSF Trustees. Our all-inclusive SMSF Administration service offers flexibility to Advisers and Accountants so they can provide their own unique service but with the knowledge that however they service their clients, the SMSF will be compliant and maximise tax benefits. Get in touch for a quote today.