- 1 What Is the IRS Depreciation Method for Commercial Real Estate?
- 2 property depreciation
- 3 Rental Property Depreciation – Are You Maximising Your Tax Deductions?
- 4 property depreciation
What Is the IRS Depreciation Method for Commercial Real Estate?
Use straight-line deprecation for commercial real estate.
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Commercial real estate is land, buildings and other structures used by businesses to earn income from rent or capital gains through sales. This type of real estate doesn't include property used for personal reasons, such as a residence. The Internal Revenue Service classifies most commercial real estate as “Section 1250” property, subject to the depreciation and capital gains rules for this type of property. However, land is not depreciable and is not Section 1250 property.
Depreciation is a tax deduction for long-lived business and investment property. You normally cannot expense the full purchase cost of business property in one year but must spread out the deductions over the property’s “recovery period.” Different types of properties have different recovery periods. The IRS uses the modified accelerated cost recovery system, or MACRS, to specify how to depreciate business and investment property. The depreciation recovery period for commercial real estate depends on whether the owner uses the general depreciation system or the alternative depreciation system. Companies normally use the GDS unless they have specific reasons to use the ADS. Certain properties used for farming or for tax-exempt purposes must use ADS.
Under GDS, nonresidential Section 1250 real property, which includes commercial real estate, has a recovery period of 39 years. In general, property owners can choose among three GDS depreciation methods: 200 percent declining balance, 150 percent declining balance and the straight-line method. Businesses recover their depreciable costs fastest with the 200 percent method but can elect to use either of the other methods. However, real property such as commercial real estate must use the straight-line method of depreciation. To take GDS straight-line depreciation on a commercial building, the owner subtracts the building’s salvage value from the purchase or construction cost. The owner then deducts 1/39th of this difference each year for 39 years. Under ADS, the recovery period is 40 years, and owners can only use straight-line depreciation.
The owner, not the lessee, deducts depreciation of commercial real estate. However, the lessee takes the depreciation deduction on a lifetime lease. In addition, a lessee can depreciate certain permanent improvements to the leased property. If you rent out cooperative apartments as a business, you can depreciate your shares of the corporation that owns the properties. If you use a commercial property for personal use, you can only depreciate the portion used for business or investment. While you can’t depreciate land, you can depreciate the cost of preparing the land for commercial use. You can’t depreciate property you hold for less than one year.
Section 1250 property has special rules governing the tax on its sale. Specifically, you must adjust the cost basis of the property by deducting the accumulated depreciation on the property before you figure your gain. The cost basis might also receive other adjustments. You treat as ordinary income the amount of the gain up to the amount of accumulated depreciation. Any gain, which is the sale proceeds minus the adjusted cost basis, beyond accumulated depreciation is a capital gain. However, corporations must recognize an additional amount of gain as ordinary gain. This extra amount is equal to the 20 percent of the excess of accelerated depreciation deductions -- those stemming from the 200 percent or 150 percent methods -- above the deductions available through straight-line depreciation. Normally, because real property receives straight-line depreciation, no extra amounts exist.
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Rental Property Depreciation – Are You Maximising Your Tax Deductions?
Are you maximising your tax deductions in Australia by claiming rental property depreciation on your investment properties? Thousands of Australians are missing out on legitimate tax deductions because they are unaware of their entitlement to rental property depreciation.
Rental Property Depreciation in layman’s terms is the reduction in value of the improvements (eg. buildings and fittings) of your rental property that you can claim as a tax deduction against your income. This does not mean that your property investment has lost value, but it takes into account that various improvements to your rental property (eg. curtains, carpets, kitchen cupboards etc) lose value over time due to various factors such as wear and tear.
Rental property depreciation represents this loss in value that can be claimed as a tax deduction against your income. You may also hear rental property depreciation referred to as a non-cash deduction, which means you do not need to spend any money in order to claim it as a tax deduction.
What Can Be Included in Rental Property Depreciation?
Rental property depreciation can be broken down into two categories – Building and Fixtures & Fittings.
Buildings (sometimes referred to as capital works allowance) are generally considered to be the permanent structures such as brickwork, concrete, roofing, tiles etc. The cost of the building can generally be depreciated over 40 years (the depreciation period) depending on the time of construction.
For example, if you built a house that cost $400,000 (excluding the cost of the land) and you depreciated it over 40 years, you would be able to claim a tax deduction of $10,000 per year (ie. $400,000 / 40 years).
Houses built prior to July 1985, are generally not eligible for depreciation, other than any improvements made after that date.
Fixtures and fittings of your rental property include items that are not generally a permanent part of the building structure. Fixtures and fittings include items such as curtains, dishwashers or furniture that is included as part of a rental lease.
The depreciation period for fixtures and fittings varies depending on what it is, but is generally intended to reflect the normal useful life of the item and will be a much shorter period than for the building (which should have a longer useful life). The relevant depreciation rates are determined by the Tax Commissioner and published on the ATO’s website.
I Didn’t Build My House, So How Can I Determine the Rental Property Depreciation?
You don’t need to have built your house to claim rental property depreciation, and you do not need to know how much the house cost to build.
The rules for determining your rental property depreciation benefits are complicated. My recommendation is to employ the services of a licenced quantity surveyor.
A licenced quantity surveyor will draw up a depreciation schedule for your property which you can then use in your annual tax return each year. In doing this, they will
- physically inspect your rental property and determine all eligible items for depreciation (ensuring you maximise your tax deductions);
- determine what parts of your rental property can be depreciated and determine a historical cost;
- apply the correct depreciation rates to each item; and
- create a depreciation schedule which will include the exact tax deduction you can claim for every year you own the property.
I have personally used Washington Brown and highly recommend them. I have negotiated a special rate for readers of this website. If you use the links in this article, or use the form that can be downloaded below, you will receive a $55 discount off the normal price for a depreciation schedule. Washington Brown operate across Australia (and also overseas), and so no matter where your property is located they should be able to support you.
As an added benefit,
- Washington Brown are extremely experienced (they have assessed more than 110,000 properties for tax depreciation across Australia), and their reports are easy to read. All you need to do is send your depreciation report to your accountant at tax time.
- The cost of employing a quantity surveyor is usually tax deductible
To obtain a quote for a depreciation schedule with the $55 discount off the normal price, use the links on this page, or complete and send the attached application form to Washington Brown to the email address on the form and they will contact you.
Update: In the May 2017 Australian Federal Budget, the Australian government announced they were changing the rules around the depreciation of plant and equipment. How this will work in practice will be subject to final legislation. We will provide an update when / if this legislation passes the Senate, or check out the latest on the budget and its implications for Aussie expats on our 2017 Australian Federal Budget page.
How Does Rental Property Depreciation and Negative Gearing Apply to Australian Expats?
The tax treatment of rental properties varies depending on whether you are an Australian resident for tax purposes or a non-resident for tax purposes. If you are an Australian resident for tax purposes your overseas investment properties may also be eligible for rental property depreciation.
Disclaimer : This information is for educational purposes only and does not constitute financial or taxation advice. As this information is not advice and has been prepared without taking into account your objectives, financial situation or needs you should, before acting on this information, consider its appropriateness for your circumstances. Independent advice should be obtained from an Australian financial services licensee before making investment decisions, and a registered (tax) financial advisor/accountant in relation to taxation decisions. To the extent permitted by law, we exclude all liability for any loss or damage arising in any way. We may receive referral commissions from companies mentioned in this article.
Capital allowance measures contain the rules for calculating the decline in value of depreciating assets.
So what is a depreciating asset? A depreciating asset is one which has a limited effective life and can reasonably be expected to decline in value over time.
Trading stock, capital works, in-house software and certain items of intellectual property are specifically excluded from the definition of a depreciating asset.
A depreciating asset has two elements of cost. The first is, generally, amounts paid to hold the asset, such as the purchase price. The second is, generally, amounts paid to bring the asset to its present condition, such as the cost of capital improvements to the asset.
The decline in value of depreciating assets is subject to Division 40. Investment property owners, generally, will need to depreciate any assets costing more than $300 each. At Ask Us Tax, as part of our customised online form, you need to simply provide details of the items purchased including the date of purchase and cost, and we will do the rest for you.
Capital works deductions relate to the deduction of construction costs and any structural improvements to your investment property over a 25-year or 40-year period.
You can claim a deduction for the construction costs of buildings and other capital works – such as structural improvements – that are used for producing income.
The deduction is available for the following capital works:
- buildings or extensions, alterations or improvements to a building
- structural improvements such as sealed driveways, fences and retaining walls
- earthworks for environmental protection, such as embankments.
If it is not possible to determine the actual construction costs, you can obtain an estimate from a quantity surveyor or other independent qualified person. You can claim a deduction for the cost of the estimate.
Different deduction rates apply (2.5% or 4.0%) depending on the date on which construction began, the type of capital works, and how it’s used.
National Tax & Accounting uses BMT Quantity Surveyors. They are national leaders in their field with offices in each state. Try our co-branded co-branded property tax depreciation calculator here . The calculator will give you an estimate of the likely tax depreciation deductions for your investment property.
If you would like further assistance in order to maximise your tax refund with respect to capital works and capital allowance deductions please contact us. We will be more than happy to assist you.
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