Before delving into what a capital works deduction is, it’s important to understand property tax depreciation (or at least some basics).
As a building gets older, its structure and the assets within the building are subject to general wear and tear. In other words, each year, the value decreases and therefore, depreciates.
The ATO allows property investors, who generate income from their properties, to claim the depreciation as a tax deduction. There are two types of depreciation deductions in the space of property investing, namely:
Plant and Equipment: also known as Division 40, “plant and equipment” refers to the fixtures and fittings that are found within the building. These are generally known as easily removable assets and include items such as carpets and air conditioning units.
Building & Improvements: also know as Capital Works, which is what this article is all about.
Who Can Claim a Capital Works Deduction?
Property investors who own income-producing properties are entitled to claim on a capital works deduction. In other words, tax depreciation deductions are available for both residential investment properties as well as commercial buildings.
How Are Capital Works Deductions Calculated?
The percentage rate at which a building depreciates is dependent on:
when construction commenced; and
the intended use of the building (i.e. commercial or residential purposes)
Property investors who own residential properties built after 15 September 1987 are eligible to claim a capital works deduction at a percentage rate of 2.5% per annum over 40 years.
Where investors make structural improvements to residential properties after 27 February 1992, they can similarly claim a capital works deduction for the cost of construction at a rate of 2.5% per annum for 40 years from the date that construction completed.
Example:
In January 2020, Carla purchased her first investment property for $410,000 and immediately rented it out.
Based on a report that she obtained from a Quantity Surveyor, the construction of the property commenced in January 2005 and was completed in October 2005. The cost of construction was estimated to be $290,000.
To determine the capital works deduction that she can claim in her tax return, she must use a depreciation rate of 2.5% as the construction of her residential property commenced after 15 September 1987.
The calculation is thus as follows: $290,000 x 2.5% = $7,250
Carla rented out her property from 1 January 2020 to 30 April 2020, so she can only claim a deduction for 121 days of the year: $7,250 x (121 days 366 days in 2020) = $2,397
So, Carla can claim a capital works deduction of $2,397 in her 2019-2020 tax return.
To determine the capital works deduction that Carla can claim in her 2020-21 tax return, the calculation is as follows: $290,000 x 2.5% = $7,250
Carla rented out her property for a full year to her new tenants, so she can claim for the full 365 days a year: $7,250 x (365 365) = $7,250
As the property was built in 2005, Carla can continue claiming capital works deductions until 2045, provided that she still owns the property and it’s being used to produce income.
Capital Works Deductions on Construction Improvements
A property investor can claim the following construction expenses under a capital works deduction:
building extensions such as adding a room or a deck;
altering a building such as adding or removing an internal wall;
structural improvements such as adding a carport or retaining wall.
Note: any expenses incurred before the construction such as architect fees, engineering fees, quantity surveyor fees as well as building permits all form part of the construction expenditure and can be claimed as a capital works deduction.
Want to know how to add capital works depreciation in TaxTank? Check out Depreciation - Building & Improvements