What you can claim for rental properties has been listed in new ATO guidelines, reports Barbara Drury.
The new guidelines issued by the Australian Taxation Office covering allowable deductions for rental property will, in the long term, give investors more certainty. In the short term, however, confusion reins.
More than 1.3 million people claimed rental property deductions in 2002-03, and many more Australians invested in their first rental property in the past 12 months.
Last week the Tax Commissioner, Michael Carmody, released an expanded list of 150 depreciating assets commonly included in rental properties and reviewed the so-called effective lives of many items - that is, the length of time they can be written off against income.
Carmody hailed the new list as providing clarity to property owners, "particularly those new to the market".
The new rules, however, apply to items purchased on or after last Thursday (July 1), which puts last year's property greenhorns in a quandary. Do they follow the old rules and lock themselves into the old rates for the effective life of their depreciating assets or take a chance and follow the new guidelines?
Investors who have already begun claiming depreciation on their rental property should continue to use the old depreciation schedule, a spokesman for the ATO says, but people who bought property in the last 12 months may choose to follow the new guidelines.
Tax accountants are not so sure. Matt Hayes, a tax partner at KPMG, refers to the ATO guidelines as "safe harbour rules" because taxpayers have the ability to self-assess, provided they feel their assessment will stand up to the scrutiny of a tax audit.
Investors might well say if the effective life for a depreciable item on July 1, 2004, is X, then self-assessing at that rate is low risk. Hayes thinks it is a risk nonetheless - especially as the Tax Commissioner is getting tough on excessive deductions. "I would be inclined to use the old rates for properties bought this year, even though you are locked in for the life of the items," he says.
Despite the confusion, Hayes believes that the changes are a good move, not only because they provide certainty but because the ATO has assembled information on rental property deductions in one spot which taxpayers can access on the ATO website (www.ato.gov.au).
An accountant and financial planner, Ian Robertson of IAC Robertson, also welcomes the changes - even though many taxpayers will be slightly worse off - because they give taxpayers certainty about depreciation rates and take away the discretionary nature of claims for items previously not included on the list.
The extended depreciation table is one of a number of measures the ATO is using to combat excessive or inaccurate rental property deductions.
In 2002-03 rental property deductions claimed by investors exceeded income received by $700 million.
A tax audit blitz on rental property owners revealed many people were claiming depreciation for capital items or structural improvements which are regarded as part of the building itself and should be written off at a rate of 2.5 per cent a year for up to 40 years. Capital items included fixtures such as spas, cupboards, lino and water tanks.
As well as reclassifying some items as capital works and extending the list of depreciable items, the ATO has reviewed the effective lives of many items.
The effective life of washing machines has been extended from six years and eight months to 10 years and electric heaters from 10 to 15 years, which means taxpayers must wait longer to recoup expenditure.
On the plus side, the effective life of floor coverings has been reduced from 10 years to five, freestanding furniture from 13 years four months to five years, and electric hot water heaters from 20 years to five.
How to value assets
Being able to claim a tax deduction for everything from toasters to teapots is a great incentive for rental property investors, but working out what you can deduct each year is a headache.
For small ticket items costing less than $300 you can claim a full deduction in year one, but for everything else you will need to reach for the calculator.
There are two methods you can use to work out the decline in value of a depreciating asset for tax purposes.
The prime cost method is the simplest, because it assumes the value of carpet or a hot water system, for example, decreases by the same dollar amount each year of its effective life.
To work out your annual deduction, take the total cost of the asset, multiply this by the number of days held over 365 and then multiply by 100 per cent over the asset's effective life.
For example, a carpet valued at $2000 with an effective life of 10 years and used wholly for the purposes of generating income for the full year would give you an annual deduction of $200 ($2000 x 365/365 x 100 per cent/10).
The diminishing value method assumes the decline in an asset's value each
year is a constant proportion of the remaining value. This means investors get a bigger deduction in the early years, when they are most likely to need it, and a diminishing deduction in subsequent years.
For example, a carpet with a value of $1200 and bought 19 days into the tax year, your deduction in year one would be $171 (1200 x 346/365 x 150 per cent/10).
Each year the base value is reduced by the previous year's deduction. So next year you would deduct $171 from the initial cost to give a base value of $1029. The calculation would be $1029 x 365/365 x 150 per cent/10, giving you a deduction
of $154.
If you have a number of assets worth more than $300 but less than $1000, they can be pooled and depreciated at a rate of 37.5 per cent using the diminishing value method. Assets added to the pool during the year are worked out at half the rate, or 18.75 per cent.
