All Topics / Help Needed! / Due Diligence – Calculation of Depreciation Expenses

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  • Profile photo of diver89diver89
    Participant
    @diver89
    Join Date: 2014
    Post Count: 2

    Hi All,

    I am a property investing newbie (haven’t bought an investment property yet) and am starting to hone my due diligence skills, in order to help me find/make positive cash flow property investment opportunities.

    One thing I have learnt from reading property investment literature is that accounting for depreciation expenses can dramatically help converting a negative cash flow investment into a positive cash flow investment.

    I am finding it most difficult, however, to determine depreciation expenses (i.e. capital works (e.g. construction costs) and decline in value of other depreciating assets (e.g. fixtures, flooring, etc), without incurring the costs of a quantity surveyor.

    I am of the understanding that if I am to be looking at multiple opportunities do determine the best property to make an offer on, then I will need to know the depreciation expenses of ALL opportunities, in order to make the best informed decision. This, obviously, could be quite costly if I need to engage a quantity surveyor for all properties that I am researching.

    Does anyone have any hints as to how this information can be more easily sourced … or am I looking at this problem from the wrong angle … e.g. is depreciation costs one of the last things that you calculate, once you have refined your list of potential properties?

    Any replies will be greatly appreciated! :)

    • This topic was modified 10 years, 5 months ago by Profile photo of diver89 diver89.
    Profile photo of superAndrewsuperAndrew
    Participant
    @superandrew
    Join Date: 2014
    Post Count: 188

    Hi Diver

    Welcome to the forum :)

    I think that you might be approaching it from the wrong angle.

    When you are searching for investment properties I would focus on the price, rent, vacancies, expenses and location of the IP first.

    It’s also important to understand the difference between cash flow income and taxable income and how they are calculated. Depreciation is a deduction and will be included in your taxable income calculation. It can bring your taxable income to a negative value (taxable loss) where you will be entitled to a tax refund. However keep in mind that the tax refund is not equal to your taxable loss but to a fraction (your marginal tax rate) of your taxable loss. Therefore it’s important not to base your investment strategy on the depreciation deduction you can get.

    Andrew

    superAndrew | Property Analyser and Finder Tool
    https://property-analyser.com.au

    Profile photo of diver89diver89
    Participant
    @diver89
    Join Date: 2014
    Post Count: 2

    Hi Andrew.

    Thanks for the tips :)

    I think I understand that depreciation expense can only be accounted for at my marginal tax rate … e.g. assuming a marginal tax rate of 37.5%, if I ‘incurred’ (on paper) depreciation expenses of $3,000, my income (tax back fom the government) from depreciation expense is $1,125. Is this correct?

    It is just that some of the literature I have been reading have been using depreciation expenses as part of the calculation to determine the feasibility of a deal. Or is this just not realistic?

    Diver.

    Profile photo of superAndrewsuperAndrew
    Participant
    @superandrew
    Join Date: 2014
    Post Count: 188

    Ok here is a quick example:

    Cash Flow Income = Rental Income – Interest – All other expenses + Tax Refund

    Taxable Income = Rental Income – Interest – Depreciation – other deductible expenses

    If:

    Taxable income (positive) = $1000 => Tax = $1000*.375 = $375 (tax payment)
    Taxable income (negative) = -$1000 => Tax = -$1000*.375 = -$375 (tax refund)

    So it’s not the depreciation * 37.5%. And keep in mind that you can have depreciation but it does not guarantee a negative taxable income.

    And yes you can include it in your calculation but I am trying to show you that other factors are more important.

    Andrew

    superAndrew | Property Analyser and Finder Tool
    https://property-analyser.com.au

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