Commercial building depreciation
Commercial property owners guide to maximising depreciation
What is considered a commercial property?
A commercial investment property is really just a property that people run a business from. It is income generating for the owner, by the way of rents from commercial tenants. Some examples of commercial property include shop-fronts, warehouses, hospitality venues, office premises, industrial properties, child and aged care centres, medical and dental practices and shopping centres.
What is commercial property depreciation?
Commercial property depreciation refers to the ageing and wearing out of a commercial building and it’s assets over time. Although a commercial building may appreciate (or rise) in value over time, from an ATO and accounting perspective, as the building ages and assets wear out they lose a percentage of their value each year. This annual decline in value is called depreciation and is claimable as a tax deduction for the property owner when completing their tax returns each financial year.
Who can claim for depreciation on commercial property?
The property owner is entitled to claim depreciation for Division 43 works (capital works) that they have paid for. These works typically include the original building, structural/built additions, and can include works over time such as newly built or upgraded bathrooms, kitchens, outdoor areas etc.
Additionally claimable is depreciation of any Division 40 (plant and equipment) assets they have paid for and included as part of the tenancy agreement.
Tenants are more likely to be claiming for the building fit-out (if they paid for it), as well as machinery, furniture and electrical assets that they own as part of their business.
For example, a cafe/restaurant business owner is likely to be claiming depreciation for the internal fit-out, fridges, bar and counter, tables, chairs and styling assets.
An office based or medical business will likely be claiming for partition walls, flooring, window dressings, reception counters, furniture, lunchroom fit-out and medial equipment.
Some works may be considered Division 43 capital works deductions (where they are structural), and most depreciation deductions will likely be for Division 40 plant and equipment assets.
How is depreciation on commercial property calculated?
Depreciation is calculated differently for different types of commercial buildings. Buildings are classified according to their use, and the ATO has set out the depreciation rules for each building classification. Factors that vary according to classification include different qualifying periods, and different effective lives (and therefore rates of depreciation) for the buildings (Division 43), as well as the assets (Division 40).
Overall, total depreciation claimable is still split between Division 43 (capital works) and Division 40 (plant and equipment). For Division 43 depreciation is calculated using a Prime Cost (or straight line) method, and whereas Division 40 assets can be depreciated using either the Prime Cost or Diminishing Value Method. Division 40 assets can also fall into low value pools during their effective life, allowing for maximum depreciation deductions earlier.
Depreciation of Division 43 (Capital Works) using Prime Cost Method
Division 43 refers to the capital works or built components of a property. This includes the all building materials used, non-removable assets such as kitchen counters, toilets etc. These assets are all depreciated using the Prime Cost Method.
The prime cost method assumes that the value of a depreciating asset decreases uniformly over its effective life.
It is important to note that depreciation is calculated from the construction cost, which is not relevant to the purchase price or valuation. A quantity surveyor will be required to effectively calculate the construction cost of the building.
Depreciation of Division 40 (Plant and Equipment) using Prime Cost or Diminishing Value
Unlike with residential property, the ATO has set down effective lives for assets that are industry specific. Carpet in a hotel may depreciate at a different rate to carpet in an office building. The ATO has published an extensive list of nominated effective lives for assets across industry classifications. That list is referred to as TR 2018/4 and can be found here.
Where the annual deduction under the Prime Cost method is the same every year, the diminishing value method assumes that the value of a depreciating asset decreases more in the early years of its effective life.
You can find great detailed examples of Prime Cost versus Diminishing Value Methods, including formulas on the ATO’s website here https://www.ato.gov.au/business/depreciation-and-capital-expenses-and-allowances/general-depreciation-rules—capital-allowances/prime-cost-(straight-line)-and-diminishing-value-methods/
A good quantity surveyor will know which rates to apply for your commercial building depreciation schedule, and will report both the Prime Cost and Diminishing Value results for the life of the asset. A quantity surveyor can also revalue individual assets at purchase (unless the values are stipulated in the contract of sale), and assign new effective lives based on their professional assessment.
Low cost and low value pooling
Assets that fall into low cost and low value pooling can be depreciated at accelerated rates. A quality depreciation schedule can ensure that assets are applied to low value pooling in the appropriate years to maximise deduction claims for those years.
Occasionally, it is better for an owner if pooling options are not utilised. If this is the case, this can be switched off within a Capital Claims schedule. In all cases this should be discussed with your accountant to provide for the best results for your circumstances.
How does claiming for depreciation reduce tax payable?
Depreciation is a non-cash deduction, which simply means it is a calculated amount rather than an expense for which you will have a receipt or invoice. A quantity surveyor will complete a depreciation schedule that will detail and summarise the depreciation claimable for the building and plant and equipment. An accountant then simply applies those figures as deductible expenses under Division 43 Capital Works and Division 40 Depreciating Assets when completing your end of financial year accounts. The affect is to reduce net profit, and thereby reduce tax payable by the owner. A depreciation schedule typically reports deductions for up to 40 years and in some cases is a one-off investment that can be used year after year.
When should I get a depreciation schedule for my commercial property?
When purchasing your building
The first time you should purchase a depreciation schedule for your commercial property is when you first purchase it. Because depreciation is calculated from the building’s construction cost, and is not related to purchase price or valuation, you will need a quantity surveyor to calculate the construction cost of the building historically, and forecast your deductions for the remaining effective life.
Some vendors may provide a depreciation schedule with the sale of the property. In this case you should ensure that your depreciation schedule has been prepared by a specialist quantity surveyor, and will be considered ATO compliant. To maximise deductions available to you, we recommend having your own depreciation schedule completed .
It is important to note that accountants are not considered by the ATO as qualified to estimate construction costs and a schedule prepared by an accountant may not withstand and audit.
When negotiating a new lease
If as part of the lease negotiations you agree to provide some fit-out or assets to the tenant, you will need to have your depreciation schedule updated to include those additions.
If the lease negotiation requires some substantial renovation of refurbishment, refer to further information below.
When you renovate or refurbish
Whenever structural improvement or additions (capital works) are completed on the property your depreciation schedule should be updated in order to maximise the capital works deductions available. Examples of structural works include building additions and improvements, electrical re-wiring, re-plumbing and hard landscaping.
Additionally, from a plant and equipment perspective if as a landlord you upgrade or update the included assets you should also have your depreciation schedule updated to reflect this. Examples of assets upgrades include air-conditioning, security systems, hot water installations and any soft furnishings provided such as carpet and blinds.
When renovating or refurbishing it is really important to ensure you have a quality, up-to-date depreciation schedule before you start removing and demolishing works. The demolished works and assets removed will still likely have some intrinsic value attributable to them. The full remaining value of the assets disposed of becomes deductible in the year of disposal.
As an example, if you were to do a complete upgrade of the bathrooms of your commercial premises, you could be tearing out tiles, basins, toilets, plumbing and electrical work that still has thousands of dollars of residual value attached to them. That means thousands of dollars of deductions claimable that year, just for ripping the old bathrooms out.
In addition to that, you will then be able to start claiming depreciation for all the new building works from when they are completed.
We recommend discussing your scheduled renovation or refurbishment with your quantity surveyor to ensure they can do pre and post renovation inspections to ensure your deductions are maximised
Who should prepare the depreciation schedule for my commercial property?
For best results, use a quantity surveyor who is a depreciation specialist and registered tax agent. Commercial building construction costs and assets can be substantially different to those we see for residential homes, and a specialist will understand the commercial scale of the building, and the industry specialised assets. A specialist will be able to more accurately value assets, assign effective lives, utilise low cost and low value pooling and immediate write-off provisions to more aggressively claims. All of this can make thousands of dollars difference to the deductions reported at the end of financial year.
Not all quantity surveyors are able to provide depreciation schedules for tax purposes. Quantity surveyors who are depreciation specialists must not only understand construction costs, but also have thorough knowledge of the tax legislation in relation to the depreciation of capital works and building assets. As such quantity surveyors who are completing depreciation schedules must also be tax agents, registered with the Tax Practitioners Board.
What happens when I sell my commercial property?
Selling a commercial property can be a complex transaction to account for and requires the expertise of an accountant who will take into consideration your ownership structure, discounts or concessions available and GST implications. ATO information relating to the sale of commercial premises can be found here https://www.ato.gov.au/General/Property/Property-used-in-running-a-business/Selling-commercial-premises/.
Purely from a depreciation perspective, when you sell your commercial property, some of the depreciation you have claimed will be taken into consideration when calculating your capital gain. Depreciation claimed under Division 43 (capital works) will be deducted from the cost base of your property. This will effectively increase your capital gain, or reduce your capital loss. This may have implications for any capital gains tax (CGT) payable at sale.
The expert accountants we work with agree that CGT implications are not a good reason for failing to claim depreciation during the ownership of your commercial investment property. Key considerations include:
• The discounts and concessions available – individuals and trusts are eligible for a 50% after 12 months of ownership, and concessions are available for small business;
• The time-value of money – the money saved during ownership will have more value (purchasing power) than it does at a later time when the property is sold;
• The opportunity cost of money – money saved earlier on can be reinvested or used to pay down debt.
It is important to note that depreciation claimed under Division 40 (plant and equipment assets), has no capital gain impact at sale. These assets are just disposed of at book value.
What happens when a tenant exits a commercial property?
Often when a tenant exists a commercial property they are required to “make good” the premises. In this case if any of the landlords assets are removed they are eligible for scrapping (immediate write-off for disposal of assets). If the owner is considering a renovation or refurbishment at that point, refer back to the section “When You Renovate or Refurbish.”
Make-good works required by the owner after the tenant has left would be considered repairs and maintenance because it is returning to premises to it’s base standard – these are immediately deductible expenses in that financial year.
Capital Claims Tax Depreciation are the experts in commercial building depreciation
To discuss your commercial building and the deductions you could be claiming for capital works and depreciation, contact our specialist team today on 1300 922 220. Or get in touch using the quote button below.
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