I want to say thank you to all of you who contacted me asking questions regarding my last email about the federal government’s pending changes to depreciation.
So I have decided to write a Part 2 to this article were I will endeavour to answer the questions asked.
But before I get stuck in, I’d like to take a step back and review the current situation and add some logical thought to it as I feel the media is adding a lot of sensationalism with scary headlines and confusing the interpretation.
I’ll start by saying – the legislation hasn’t been passed yet.
Let’s think about this for a moment… and let’s be logical.
Logical thought #1 – we all know that there is a shortage of housing in this country so it makes good logical sense that the government would want to promote or increase the building of new properties rather than the opposite.
Logical thought #2 – and it makes sense that the government wants to increase taxes to pay for all their budget initiatives (der… obviously 🙂 ). Therefore it’s fair to say that they want more houses built and more taxes.
“Helen, but if developers are the first owners of the property, then buying new makes us investors the subsequent owners and therefore don’t qualify for depreciation benefits, right?”.
If this were true, then logically, investors would stop buying, which would slow or stop developers building more properties, which in turn would have a devastating effect on the housing market.
(BTW, our housing market is one of this country’s biggest industries so if it slowed down or stopped, the knock-on effect would potentially include massive job losses, increases in unemployment, failed business and therefore reduction in taxes for the government to collect. But for the sake of this article – let’s not go there.)
Logically it would go against what the government is trying to achieve, that is, more houses, more taxes.
With that said, the real question is, “who owns the brand-new property when built and who is the subsequent buyer?”
Logic tells me the answer is – the 1st Buyer.
Let me explain…
For example, when you buy (let’s say an off the plan unit or a house and land package), the developer/builder owns the land and prepares a contract of sale for the land and the approved building.
You borrow the money from the bank and pay the developer/builder to construct the building.
Once completed, you settle and take possession of the building. The building includes plant and equipment assets (aka chattels) that can be depreciated as can the building.
So, the developer/builder might own the land but… YOU CAN NOT DEPRECIATE THE LAND.
Depreciation relates only to the building so if you can purchase the land from the builder AND the new building, then it makes sense that YOU are the 1st Buyer and not the subsequent buyer.
Where it gets tricky is when…
Let’s say you are the 1st owner of a property, then after two years, you need to sell and I purchase the property from you.
During the two years, you obtained a depreciation schedule and claimed it at tax time.
But as I am the subsequent buyer, do I miss out on the balance of the depreciation schedule OR can I continue to claim it at tax time, LESS the two years that you have already claimed?
This is the question that I can’t find the answer to just yet – well, not officially on a government document anyway, so I will be watching this space carefully and will share more with you when I find out in due course.
So therefore, following this logic and from what I know at this point in time, if you are the first buyer, then it stands to reason that there should not be any change to claiming depreciation at tax time.
Now – my disclaimer!
As the legislation hasn’t been passed yet, no one knows the full outcome of the situation including me, however I am happy to share my thoughts and I await eagerly to read the fine print when it is released.
Now for the next point
I hear that some of you have pulled out of deals simply because you are worried about the impact of the federal budget changes. I teach my students that property investing is a long-term strategy and the way to create real wealth is through capital growth and not saving tax.
So let’s look at an example.
If you buy a $600,000 property, and let’s assume it grows by 10% per year, then you have roughly created $60,000 in equity per year (excluding compound interest as I want to keep the numbers simple for people to understand my thinking).
Over 5 years, you would have created roughly $300,000 in equity.
Let’s compare your equity growth to tax incentives over the same 5 years.
I decided to jump online and run some numbers using BMT’s depreciation calculator as a guide for this example. (Yeah, happy to give these guys a plug.)
Here are the variables I entered.
The estimates are as follows:
So for this type of property, and based on a tax rate of 37%, the range of claimable depreciation for the minimum is $10,700 or a maximum of $14,200 in the first year.
Remember this is only a guide.
Show me the money…
And now, let’s look at what the calculator says you could expect to receive in tax return (using the 37% tax rate). In year 1, it would nearly be $4,000 for a minimum and just over $5,000 for maximum.
Over the five years on the maximum level, the calculator says that you could roughly end up with an additional $21,000 in your back pocket.
So let’s compare the numbers over five years:
Equity growth of $300,000 versus a tax saving of $21,000.
Which would you prefer?
Well, if you are like me, you’d say both! 🙂
But it’s tragic to hear that investors are currently pulling out of deals right now due to ‘what might happen to depreciation’ without clearly crunching all the numbers and are acting out of fear.
REMEMBER! This legislation is about depreciation and not capital growth. And therefore, should not be the determining factor on whether you buy or not.
LET ME REPEAT
I always tell my students to invest for the long term and to treat tax time as a bonus, not a necessity. If you need tax benefits to sustain your property, then you may need to review your situation with your mentor and experts.
The Good News – If you bought properties prior to the new legislation, then nothing changes for you – hooray!
Thank you again to all those who connected with me about my previous article, I hope part 2 helps to clarify your questions further. (And you know who you are : ) ).
P.S. just one more thought I had, if the government gets this wrong and stuffs up the property market, we could potentially experience another boom market either in property prices or in rents going up due to a shortage of available rentals.
P.P.S. I have also added BMT’s disclaimer just to be sure that you understand that the calculations in this article are estimates only and that you should seek professional advice before making any financial decisions. 🙂
From the BMT website
2017 Federal Budget
Under proposed changes announced in the 2017 Federal Budget, residential property investors who exchange contracts on a second-hand residential property after 7:30pm on 9th May 2017 will no longer be able to claim depreciation on plant and equipment assets, these properties will still have a deduction available on qualifying capital works.
All properties acquired prior to this date will not be affected. We will shortly be adjusting the calculator to accurately reflect the changes.
Investors who purchase a new property will be able to continue to claim depreciation as they were previously. These changes will affect the total deductions outlined within the results table of this calculator for properties purchased after this date.
We are currently speaking with government to further understand the intricacies relating to the proposed changes.
If you have any questions or require a depreciation estimate for a property purchased after 9th May 2017 please contact our office on 1300 728 726.