Two depreciation methods help to increase cash flow

Recently we looked at how Australian property investors can improve the cash flow earned from an investment property by claiming depreciation.

In Australia, depreciation can be claimed on investment properties as capital works deductions for the wear and tear of the structure of the building (eg. walls, floors, roofs) as well as for the removable or mechanical plant and equipment assets (eg, carpets, blinds, furniture, ovens, hot water systems) contained inside the property.

When it comes to the assets contained within the property, it is important for investors to be aware that two methods can be used to claim the depreciation deductions available for these assets. These are the prime cost method of depreciation and the diminishing value method of depreciation.

Both the diminishing value and the prime cost methods claim the total depreciation value over the life of a property. However the two methods use two different formulas to calculate depreciation deductions, achieving different short and long term cash flow positions for the property investor.

Under the diminishing value method, the deduction is calculated as a percentage of the balance you have left to deduct, while the formula used for the prime cost method is calculated as a percentage of the cost.

The two formulas used are outlined below:

Diminishing value method:

Prime cost method:

The strategy of the individual investor must be considered when determining which method is the best choice for an investor.

If an investor makes their claim using the diminishing value method, they are claiming a greater proportion of the assets cost in the earlier years of the effective life of the asset as set by the Australian Taxation Office, therefore receiving greater deductions in the earlier years of owning the property.

Alternatively, by selecting the prime cost method, an investor will receive lower deductions in the earlier years of ownership, but deductions over the long term will be more constant.

No matter which strategy an investor has, it is recommended to seek advice from an Accountant when making a decision and to consult with a specialist Quantity Surveyor to request a tax depreciation schedule that outlines the deductions available using both of these methods.

BMT Tax Depreciation recently conducted a sample study of BMT Tax Depreciation Schedules and analysed how the two different methods of depreciation for assets affected the outcomes of claims over a five, ten and fifteen year period. To read the full article including the case study from BMT Tax Depreciation, please click here.

Article Provided by BMT Tax Depreciation.

Bradley Beer (B. Con. Mgt, AAIQS, MRICS) is the Managing Director of BMT Tax Depreciation.  Please contact 1300 728 726 or visit www.bmtqs.com.au for an Australia-wide service.