Over the last 30 years or so the quantity surveying industry has waxed lyrical about all things property tax deduction related, the most recent being property tax profiling. 

Obviously, quantity surveyors would like to think as an industry we’ve added some value and therefore made a very positive difference to our clients after tax bottom-line. 

We have sliced and diced property tax every possible way, providing the platform for balance and maximum return from your property investments and we’ve also tried to address the perception that you can’t afford it. An affordability study needs to address a variety of property information to provide a balanced view of how your asset might perform over a period of time and how you can influence that performance. 

Whether the investment is residential or non-residential the same basics apply:  

• What will it cost?
• What are the risks involved? And
• What return will I secure?

These questions have multiple layers:

• What will it cost (short, medium and long-term)?
• What kind of costs are they (capital, repairs and maintenance, refurbishments or compliance costs)?
• What are the legal obligations?
• What must I spend to benefit and retain the tenant?
• What risks are involved (physical, compliance or tenant retention)?
• Who ‘makes good (repairs)’ the space at lease expiry?
• How do I maximise and maintain my return?
• Are there development opportunities that will add value to the property?  

If you consider all of these questions about your asset in isolation, they provide some useful information. However, the maximum benefit is achieved by considering all these issues at once, to create a clear profile of how your asset will perform over time, thereby providing certainty, clarity, sound information for a financier and a strong platform for your accounts.  

In one illustration, a commercial investment property is purchased for $5,250,000. The initial return is 8 per cent with $420,000 annual rental. The property has 1,600m² net-lettable area and is 10 years old. A lease is in place for five years with fixed rental increases of 4 per cent so at lease end, the possible value of the asset at 8 per cent is $6,387,000. Not a bad gain over five years – if it can be achieved.  

However, in addition to financing costs over the lease period, a building of this age will also have other physical costs associated with ownership over time. These need to be considered, planned and managed to keep the property aesthetically and functionally attractive beyond the current five year lease to retain future value. Assuming your pre-acquisition due diligence study provides details of the risk factors associated with the property and notes that the related capital expenditure and repairs over five years it is likely to be between $350,000 and $400,000. This will fund works such as Building Code compliance issues, replacement of floor coverings, services upgrades, painting and general upkeep.  

The cost of the capital works and repairs are tax deductible against income in differing ways however they also have recurring cash flow impact. Offset against ongoing costs of ownership are the tax deductions available for building allowance and plant depreciation for the initial acquisition and again for additional expenditure throughout ownership. These deductions provide additional cash flow benefit and after-tax dollars to go towards funding future upgrade works on the asset.  

The affordability may still be an issue but again there are a number of tax deduction areas where you can claim deductions without any initial outlay.  

Money for nothing and your tax for free, ‘How does it work?’ you say. Well, it goes something like this:  

Your tenant has 1,000m² of space. Ten years ago at the beginning of the lease they spent $900,000 fitting out the shell you provided. They have now made a decision to relocate. As part of the make good settlement, an amount of $300,000 is agreed and they walk away. You are left with a ten year-old fit-out, wondering what you should do. Will a new tenant come in the space at the right rental, or will you have to return the space to base building? 

Answers to these questions can be significantly impacted by the following:  

• The lessee claims the write-off of any un-deducted value of plant and equipment only that has been abandoned as a result of the move; and
• As the base building works that were carried out by the lessee (fixed partitions, ceilings, power, pluming, etc) were not demolished by the lessee, the un-deducted value of these works passes on to the vendor in accordance with the rules of Division 43 of the Income Tax Assessment Act (ITAA). The value of the ‘give away’ should be considered by the lessee in the make good settlement. 

Facts for the Landlord:  

• The $300,000 received from the tenant for their make good liability goes into the landlord’s books as assessable income; 
• If the fit out is subsequently demolished, and $300,000 is spent in making good, then the make good works will qualify as repairs and are therefore immediately deductible as long as there are no improvement works carried out during the make good; and  
• The un-deducted value of Division 43 building allowance (base building type items) enters the books of the landlord at approximately $200,000. This amount is deductible if the fit out is demolished. Otherwise, an annual deduction of approx $6,500 can be taken for this fit out that has cost the landlord nothing. This deduction, if taken, will reduce the capital gains cost base of the asset.

Now if you think that you have misread this, you are mistaken. People are conditioned to think that nothing in life is free. However, the fact is that in this instance, it is a free kick as far as after cash flow is concerned. To a landlord, it represents a significant after tax return.  

In summary, under the ITAA there are many legislated ways to generate a tax deduction:  

• The initial depreciation schedule when you build or buy (new or old), that defines the platform for your deductions going forward; 
• Deductions against the cost of fitting out a space; 
• Future deductions for additional unexpected repairs and maintenance; 
• Write off of the remaining value of the demolished items; and  
• Write off any future deductions from inherited fit out.  

The affordability consideration should capture all of the above information and take the form of a property tax profile which will allow you to:  

• Understand, plan and manage all costs associated with the physical ownership; 
• Manage all building risks associated with ownership; and  
• Manage your true return proactively, by controlling cost and risk and efficiently capturing all available tax benefits.

 So not only can you afford it, you can maintain a solid return as well, with no surprises.  

Written by Paul Mazoletti
Displayed in REIQ Journal May 2013

………

Using depreciation as a way to encourage the greening of the build environment has been a hot topic for a number of years. During the recent federal election the Labor party announced policies that included the delivery of such incentives.

Last week via their web site Labor provided a little more flesh to their approach in this area.

We outline the salient details below:

• Scheme starts from 1 July 2011 – 30 June 2015.
• Applies to Retro-fits of existing buildings.
• Applicable to buildings 2 Star NABERS rating or lower looking to achieve 4 stars or higher.
• Available for Office buildings, Hotels and Shopping Centres.
• Provides a 50% increase in deductions over the life of eligible assets.
• Anticipated cost $1bn.

How does it work?

• The scheme will run in the same manner as the recent investment allowances scheme.
• From the 1 July 2011 applications will need to be made to the Government for review and approval prior to any works taking place.
• NABERS assessments will be required before the works commence.
• Upon completion of the works 12 months will need to pass to enable a post construction NABERS assessment to be completed.
• Application with results will need to be submitted to the Government for approval.
• Claim for depreciation may be made with approval in that year accounts.
• Depreciation claims that would otherwise be available can be claimed from the date of practical completion.

The Good

• Fairly generous deduction available given the scale of likely expense to achieve a two star rating increase.

The Uncertain

• This is a proposal and not final legislation.
• There is no current indication what assets will be considered eligible for the 50% allowance.
• The $1bn may be capped by the Government so fewer projects may be eligible.
• How the Government will effectively assess applications.
• Likely to take 3 – 4 years before the incentive reaches owners returns.

Napier & Blakeley’s head of sustainability Roger Walker is one of the members of the committee reviewing the assets that will be included within the scheme.

Napier & Blakeley will keep you informed as more information comes to light. In the mean time should you wish to discuss the above article or any other matters relating to Sustainability or Tax Depreciation please does not hesitate to contact us at Napier& Blakeley.

NSW / ACT / WA / NZ  -  Roger Walker, Alastair Walker -  02 9299 1899
VIC /  SA  / TAS  -  Peter Frith, Rob Howells -  03 9915 6300

A number of our articles have covered a variety of individual topics in isolation but in reality they’re all inextricably linked providing the platform for balance and maximum return from your property investments.

Our affordability index provides an amalgamation of a variety of property information to provide a balanced look at how your asset might perform over a period of time and how you can influence that performance.

Whether the investment is residential or non residential the same basics apply –

§          How much is it going to cost me

§          What risks are involved

§          What return will I secure

These questions then have multiple layers – how much is it going to cost me initially and in the short and long term, what kind of costs are they, capital, repairs and maintenance, refurbishment or compliance costs. What must I do legally, what must I spend to benefit and retain the tenant.

What risks are involved, physical, compliance or tenant retention, who ‘makes good’ the space at lease expiry.

How do I maximise and maintain my return and are there development opportunities that will add value to the property.

If you consider all of these questions in isolation they provide some useful information.

But only by considering all these issues at once you can create a clear picture of how your asset will perform over time, therefore providing certainty, clarity, sound information for a financier and a great platform for your accounts.

As an illustration, a commercial investment property is purchased for $5,250,000 the initial return is 8% with annual rental at $420,000. The property has 1,500m2 net lettable area and is ten years old.

A lease is in place for 5 years with fixed rental increases of 4% so at lease end – the possible value of the asset at 8% is $6,142,000.

Not a bad gain over five years if you can achieve it.

However, in addition to debt costs over the lease period, a building of this age will also have other costs associated with ownership over time and these need to be considered, planned and managed to keep the property aesthetically and functionally attractive beyond the current five year lease. No future lease – substantially less future value.

The pre acquisition due diligence study provides details of the risk factors associated with the property and notes that the related capital expenditure and repairs over five years is likely to be between $350,000 and $400,000 to carry out works such as Building Code compliance issues, replacement of floor coverings, services upgrades, painting and general upkeep.

The cost of capital works and repairs are tax deductible against income but obviously they also have a recurring cash flow impact.

Offset against ongoing costs of ownership are the tax deductions available for building allowance and plant depreciation deductions for the initial acquisition and again for additional capital expenditure throughout ownership. These deductions provide additional cash flow and after tax dollars to fund any upgrade works to the asset.

The affordability index captures all of the above information and allows you to:

§          Understand, plan and manage all costs associated with ownership.

§          Manage all risks associated with ownership.

§          Manage your true return proactively, by controlling cost and risk and capturing efficiently all available tax benefits.

So not only can you afford it, you can maintain a solid return as well with no surprises.

If during the current financial year you owned an investment property and earned an assessable income from it then you are entitled to tax deductions for wear and tear or depreciation as it is more commonly known.

Over the last 22 years Napier & Blakeley has analysed many thousands of properties, preparing depreciation schedules for owners of virtually every type of property ranging in value from a few hundred thousand dollars to in excess of one billion dollars in value.

There are well in excess of one million property investors within Australia and we suspect that the majority of property owners in Australia do not fully maximise the deductions which can significantly affect and increase their after tax yields.

In a recent analysis of a five year old commercial office building with a purchase price of $5m, a land value of $1m and an income of $500,000 we found the following.

If you claimed no depreciation and building allowances, your after tax income at the following rates would be:

                45 per cent = (highest individual tax rate)                       =$275,000  

30 per cent = (company tax rate)                                      =$350,000

15 per cent = (superannuation fund tax rate)                 =$425,000

However, if you did claim the available deductions, your after tax income would be greatly increased as follows:

45 per cent =$365,000       giving a 33% increase in after tax return         

30 per cent =$409,000       giving a 17% increase in after tax return         

15 per cent =$455,000       giving a   7% increase in after tax return         

As with lifes two certainties, death and taxes, we can guarantee you that if you don’t claim these available allowances, the ATO wont go out of their way to let you know what you’re missing out on!

Below are some questions you should ask yourself to see if you have passed the yearly Tax Depreciation rego:

o         Have you acquired an investment property of any age, type or state of repair?

o         Have you completed any construction works ?

o         Have you completed a fit out ?

o         Has a tenant left your property and you have inherited their fit out ?

o         Has a tenant left your property and you have removed their fit out and made good ?

o         Have you paid any $ towards a tenant fit out

If you have answered yes to any of the items in the tax depreciation rego form and have not considered that there could be tax deductions available to you. N&B can assist with getting your Tax Depreciation rego certified and in order for the last financial year.