- By Zac Gleeson
- Apr 03, 2016
the Opposition outlining its platform for changes to negative gearing, and the Government refusing to rule them out, does this signal an end to tax depreciation on investment properties?
With debate raging on the implications of proposed changes to negative gearing and Capital Gains exemptions, there is a further consideration for property investors and their ability to offset the ônon-cashö loss of income generating assets via depreciation.
Depreciation of capital and plant and equipment associated with an investment property is very much wedded to the benefits of negatively gearing a property, allowing an owner to offset ônon-cashö losses against other taxable income. Over the shorter term it reduces an individual’s personal tax liability, while over the longer term, reducing the cost base and allowing the Government to gain a greater take of tax on the sale of the asset. This delayed approach had the impact of encouraging investment in low yielding asset classes.
Why claim depreciation on an investment property if you cannot offset the loss?
Any proposed changed by either the Government or the opposition which impact negative gearing may have a flow on impact to the overall benefit of Depreciation.
Investors are asking, ôwhy would I want to claim depreciation on properties that are negatively geared in the current year when it won’t reduce my income but will have the impact of reducing my cost base when I sell?ö This view is that investors will only want to claim depreciation on properties that are cash flow positive – to a point where they are breaking even.
Sian Sinclair of Grant Thornton explains that claiming depreciation is an incentive that is available, but isn’t a choice û if you don’t claim it in full you may miss out. The adjustment to the cost base of an asset has to be made regardless of whether you have chosen to claim depreciation in the past or not, so why miss out on claiming the entire deductions that are, at least partially, going to reduce your cost base anyway.
The current government is remaining coy about negative gearing, however has ruled out changes to CGT exemptions (at least outside of superannuation). It appears that their preference is for a cap on deductions, perhaps up to a percentage of their income.
Taking the assumptions made as part of Labor’s proposed reforms currently under scrutiny, we can look at a worked example of a new negatively geared property purchased for the median BCC House Sale price (as at January 2016), of $610,000 to demonstrate the impact. Assuming the property was neutrally geared prior to depreciation being applied and remained so for the 5 year holding period.
If we assume a 5 year holding period on the investment the current capital allowance depreciation deductions under Div 43 is $27,500 over the 5 years. Under the new proposals there would be no direct benefit from claiming depreciation year on year as there is no direct effect on the property investor’s cash flow and no ability to offset any ôlossesö against personal income.
When the investment runs its course over the 5 years under the current rules, the net effect of the cumulative depreciation offset is likely to be as high as $15,939 based on a marginal tax rate of 37%.
The real loss directly impacts the net tax position of the property investment when the property Investor sells the asset as it results in a typical Investor paying approximately 84% more in tax on their investment property over a 5 year holding period.
When directly considering the effects of the proposed changes on depreciation relating to negatively geared existing properties purchased post 1 July 2017, the effect could be dramatic. Depending on how deducting the cumulative losses on the property is handled within the CGT calculation, depreciation will still need to be known at the CGT event to reduce the capital gain. However the difference depreciation makes on CGT is diminished by the decrease in the exemption. Also, the cumulative losses are deducted from the Capital Gain but the Investor has received no tax benefit from those losses throughout the holding period which also reduces the positive effect depreciation has on an Investor’s cash flow.
Who wins and who loses?
The incentive to produce income generating assets rather than focusing on the tax liability incentives is likely to change an investor’s portfolio mix which is also likely to have an impact on demand for certain types of property. This may also change the dynamics of financing these investments if the incentive to negatively gear a property is removed. Over time it may give rise to a greater need for depreciation as a result of cash flow positive properties needing to offset non-cash losses against the profits generated on a positively geared property.
So who wins under these proposals? Is it purely an opportunity to raise revenue for the government as an alternative to a change in the GST or a safer bet then taking on superannuation? Are there bigger winners and losers falling out of the longer term impacts to the property and finance sectors?
One thing is clear, Depreciation is here to stay. Investors need to talk to their Quantity Surveyor and their Accountant to make sure that they are keeping the correct records and making the most of the entitlements offered now and moving forward.