Hi, just read the excellent article “Negative Gearing… Friend or Foe?” at http://www.propertyinvesting.com/strategies/negativegearing.html
I am however a little confused by the what is stated in “Truth #2: The dangers of depreciation” and would like someone to clarify the situation for me.
“…you don’t avoid paying tax with depreciation, you just defer it. Commonsense suggests that depreciating an appreciating asset like property will give you a tax deduction today, but you’ll have to repay it in the form of capital gains tax at a later date when you sell.”
Say I bought a property in 2000 for $400,000 and I claim depreciation of $10,000 per year until I sell it in 2005 for $500,000.
Does this mean my capital gain is $100,000 ($500,000 minus $400,000)?
Or is my capital gain actually $150,000 ($500,000 minus $400,000 plus 5 years times $10,000 per year)?
Would really appreciate someone clearing this up for a novice like me. Thanks in advance!
Altered, because I completely stuffed the answer up, oops…[withstupid]
Thanks Dazzling
G7,
I think depreciation does have quite a bit to do with the CGT. That’s why all of these investors claiming buku depreciation on brand spanking new apartments and the like are strongly advised never to sell by certain organisations.
When you sell, all of the ‘good’ from depreciating assets is literally taken away. That’s why lots of developers don’t ever claim depreciation on their new structures, as they know when they eventually sell them, they’ll have to give it all back.
This really is a subject for a person who does nothing but work in this area.
Cheers,
Dazzling
“No point having a cake if you can’t eat it.”
yes you will have to pay it back. Just to comment on a few points of Truth 2:
Truth #2: The dangers of depreciation
Buying a property based on depreciation benefits is dangerous and deceptive.
A little emotive….
Depreciation is an accounting term used to describe the wear and tear of an asset that occurs over time. In practical terms, depreciation on a property refers to the carpet wearing down, the walls becoming chipped or stained and the furniture dating.
In most new properties you are allowed to claim a tax deduction for the depreciation of the fixtures and fittings and in certain circumstances you may also claim a building write-off of either 2.5 per cent or 4 per cent of the property (not land) value too.
Slick marketing companies sell the notion of the taxman paying off your property using depreciation and building write-off deductions, but this sales pitch is quite deceptive because you don’t avoid paying tax with depreciation, you just defer it.
but cashflow is what CF+ investing is all about, so I am not sure why you wouldn’t consider the taxman helping to fund your cashflow to be an excellent benefit. And there is the possibility that you will never sell and thus never pay it. You may even demolish the whole building at some point, write off the remaining balance and selling a vacant block of land.
Commonsense suggests that depreciating an appreciating asset like property will give you a tax deduction today, but you’ll have to repay it in the form of capital gains tax at a later date when you sell.
CF+ investing suggests that cap growth is just a possibility that may never happen and hence you should chase cashflow. so if the cap growth never occurs, you will never have a liability (other than the claimned depreciation which is the same regardless of the cash flow of the property). personally I would claim depreciation even on CF+ property
‘Bracket-creep’ issues can catch out many taxpayers too. If you earn $50,000 when you buy the property you will only be able to claim a deduction for depreciation at 43.5 cents in the dollar, but if your income rises to $60,000 when you sell then you’ll need to repay the depreciation at 48.5 cents in the dollar.
ye sbut you are talking about a future dollar not a present dollar. besides which, tax brackets do get adjusted as we have seen recently.
If you don’t ever plan to sell the property then at a minimum you should recognise that your depreciation tax deduction represents the wear and tear on your asset that will need to be eventually refurbished in order to continue attracting quality tenants.
applies to any property. if the item is replaced you simply start claiming again.
Finally, beware any financial model that allows for depreciation benefits but does not include a maintenance budget. You cannot have depreciation without an expectation of repair costs – even new properties still need tap washers replaced.
once again, applies to any property.
Whether you claim a deduction for depreciation is up to you at the end of the day. For the same reason that I would recommend people take a weekly variation in their weekly tax deductions I would also recommend claiming the depreciation. Cliche one: cashflow is king…. regardless of CF- or CF+, cashflow reduces the burdon. Cliche two: a bird in the hand is worth two in the bush
http://www.megainvestments.com.auJohn Carroll
Despite my best efforts of explaining things to them very slowly, journos keep getting things half right. Sigh.
Here we go again:1. It’s only depreciation claimed on the building that impacts upon the capital gain. Depreciation claimed on the fixtures and fittings doesn’t come into it.
2. So if you have claimed, say. $10,000 in building depreciation over 3 years of ownership, then you effectively pay CGT on half of this (remember, the 50% CGT discount for assets held longer than 1 year).
3. Here’s the kicker. On any property purchased after May 13, 1997, you need to deduct the eligible building depreciation from the cost base upon sale whether you have claimed it or not.Very few accountants are aware of this.
So if you don’t claim it and the ATO quiz you on your CGT calculations, you’ll get hit anyway.Scott
Tax Depreciation Schedules
Australia wide service
1300 660033
[email protected]
http://www.depreciator.com.au
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