Depreciation: Diminishing or Prime cost?

Discussion in 'Accounting & Tax' started by Comet, 3rd Aug, 2023.

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  1. Comet

    Comet Member

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    Hi there,

    I just have a question about what would be best in our case. We have recently purchased a holiday townhouse, which we will predominantly letting out. I am currently furnishing etc. It is bought in my name, not jointly with my husband. As my income is going to be low in the coming financial year, and all the initial costs currently going into furbishing the property (including a lot of items under $300), it is highly likely there will be a negative income for this financial year. But we should see a reasonable income for the years following. So I was thinking that perhaps Prime Cost would be better for us. Most furniture items I feel should have depreciation value of around 5 years... But of course, inflation.

    Thanks for any help
     
  2. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Seek tax advice as your private use may render all depreciation (Div 40) non deductible and the Div 43 will need a private use adjustment. And any furniture etc that is used is ineligible anyway. The assets then are "used" from the first use privately. You should also keep exceptioal records of your use. And many think they can use it because its vacant...Yes you can but its still private use and this reduces all deductions other than direct rental ones (eg fees for bookings) And its not a case of 4 weeks /52... If the 4 weeks were in Xmas / NY the ATO would have issues. The 4 weeks at a higher lost rental rate may equate to a 12 week private use adjustmnet as a example. If they arent happy they can cancel the loss rather than argue. See Ruling IT 2167

    Generally speaking DV brings the same deductions fwd. PC spreads it out. I say a deduction today is always better than later. If marginal tax rates were materially different early on that may influence it. Once a method if chosen you are locked in.

    You dont need to consider the rental income in respective years... The effect is based on the owners marginal tax rates. And effective life of furnishings is 13.3 years meaning the tax rate is 15% not 20% based on a 10 yr effective life. Have a QS produce a schedule.
     
  3. Comet

    Comet Member

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    Thank you. I'm aware, about the occasional private use adjustment, and that's not an issue; it won't render it non-deductible. I agree about a deduction today etc., but the deductions for DV for the first year, won't reduce my taxable income, because my taxable income will be in the minus (we won't make any money in the first year, the year of the biggest deductions), so wouldn't it make more sense to use PC? And I can change the effective life to less than the '13.3' years as far as I'm aware? I've done this whole thing before, but it was a good few years ago now, and we were joint tenants. We've done it this way, as my husband is in a higher tax bracket, and we wish to make income on the property, rather than negative gearing it as we did last time (perhaps that has been a mistake this time).
    I appreciate your time. Thanks
     
  4. danielcannan

    danielcannan Well-Known Member

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    Generally speaking people tend to go for DV, as it generally provides a greater deduction in earlier years. A dollar today is worth more than a dollar tomorrow is the rationale. For your specific circumstances it's best to seek personalised advice.
     
  5. Mark F

    Mark F Well-Known Member

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    I wouldn't adjust the depreciation rate unless you have a strong argument to do so. You don't have to justify the ATO depreciation rate but you need to be able to justify the change when asked so "I feel it should be 5 years" will not cut it. Also inflation has nothing to do with depreciation.
     
  6. Comet

    Comet Member

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    Thanks. There is a strong reason to change the time period: the furniture in holiday lettings sustains substantial wear and tear, and will need to be completely replaced after several years, particularly in order to keep renting out at an appropriate nightly rate. 13.5 years would be way too long.

    Contextually, inflation certainly does have something to do with depreciation, which is why most opt for the DV method: $200 is worth a lot more now, than it will be in 5 years, because of inflation.
     
  7. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Once you live in it, or stay in it, you will no longer be able to claim depreciation except for building works perhaps
     
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  8. Comet

    Comet Member

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    That's not at all true. If we use it for 4 weeks a year, it is only those 4 weeks we can not claim for. See 'holiday home, part year rental' Holiday homes
     
  9. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Guide to depreciating assets 2022

    Self assessing is a option BUT as a new owner of property you dont have experience to determine what the effective life may be. It could be a risk. And then if the assets are in private use these assets may not be eleigible for any Div 40. The rules are complex and best guided by a QS like BMT. Their industry body had aexcellent paper on the issue based on the legislation papers that explains it well.

    The rules consider if the assets were acquired and how. If another person first used them its fatal. Then the laws dont always fully explain other issues eg CHANGED use. Some use and regular use. There is a exception for occassional use but its very infrequent and brief and may be the concern here.

    An asset has been ‘previously used’ if:

    • the taxpayer did not hold the asset when it was first used, or first installed ready for use (other than trading stock) — i.e. the taxpayer purchased it second-hand from another entity; or
    • at any time during the income year or an earlier income year, the asset was first used or installed ready for use, either:
    in residential premises that were one of the taxpayer’s residences at that time; or

    for a purpose that was not a ‘taxable purpose’ and in a way that was not occasional

    A private ruling on the experience of actual use may assist. And then need contnual care to avoid breach. A ruling which is favourable and the use varies from that described to the ATO would be a poor ruling to rely upon

    I wouldnt claim Div 40 if you stayed 4 weeks a year without a ruling.
     
  10. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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  11. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Hence the ruling preference. Occassional.........? Suggests from time to time but does 4 week trigger or 3 nights etc ?? 2(d)(ii) means that interpretation is that of the Commissioner until better determined on appeal. The QS body had a internal paper that was given explanation by the ATO and it took the view in a count of numbers of nights...days not weeks. But it wasnt a ruling. I expected ATO to indicate what they mean in a public ruling but... they didnt.

    I have also felt d(i) could be fatal..."one of your residences at the time". Doesnt say main residence and doesnt refer to any useage conditions. One night ?? The QS paper never mentioned that at the time. . So owner occupation for one night coud be fatal. Unlike if they allowed a brother to stay a few nights for free.
     
    Last edited: 4th Aug, 2023
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  12. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Until a private ruling is issued I would stand by my answer
     
  13. Comet

    Comet Member

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    Thanks for all that. Firstly, I have owned many properties, and I've done this with a holiday property before. I understand the 'used items' which came into effect in 2017. That's not of concern here. DV is quite clearly allowable under the circumstances I describe, if we were staying 4 weeks not in peak holiday period, as is described on the ATO website here (see 'holiday home, part year rental'): Holiday homes

    None of this is my concern (or question). At any rate, I think I've worked it out that DV would probably be better than prime cost, as I defer the loss to subsequent years anyway, and better to claim more earlier.
     
  14. Comet

    Comet Member

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    That's the info on the ATO site, and it's pretty thorough, I find. I've done this before and depreciated everything then, despite staying in it a good few weekends ourselves; you just have to pro-rata the deductions. It's not an issue. I was just trying to work out whether DV or Prime cost would be better given our current circumstances, but because I can defer a loss, probably will go with DV.
     
  15. Comet

    Comet Member

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    Actually, allowing the brother to stay for a few nights for free, is far more risky than owner occupation for four weeks outside of peak time. I'm quoting the four week example directly from the ATO website. Here it is in full:

    "
    Example – investment property made genuinely available for rent, with minor private use

    Gail and Craig jointly own a holiday home which they rent out at the market rate to holiday makers. They have a property manager at a local real estate agent advertise it for rent during the year and communicate regularly to ensure the property is being managed. Gail and Craig consider renting out the property on a long-term lease; however determine they can derive more profit from short-term rental.

    The property is available for rent during all holiday periods, including weekends, school holidays, Easter and Christmas. Gail and Craig use the property themselves for 4 weeks during the year, in 'off-peak' periods when they are unlikely to find tenants.

    During the year, Gail and Craig’s expenses for the property are $36,629. This includes $1,828 for agent's commission and the costs of advertising for tenants. It also includes interest on the funds borrowed to purchase the holiday home, property insurance, maintenance costs, council rates, the decline in value of depreciating assets and deductions for capital works.

    Gail and Craig receive $25,650 from renting out the property during the year. They can claim the full amount for agent's commission and advertising ($1,828) as a deduction. The other expenses incurred by Gail and Craig ($34,801) can be claimed based on the proportion of the income year the property is rented out or is genuinely available for rent. They can't claim any deductions for the 4 weeks they use the property themselves.

    Gail and Craig’s rental income and deductions for the year are as follows:

    • rent received = $25,650
    • rental expenses ((48 ÷ 52) × $34,801) + $1,828) = $33,952
    • rental loss is $25,650 − $33,952 = ($8,302).
    As they are joint owners, Gail and Craig claim a rental loss of $4,151 each in their tax returns.

    Gail and Craig need to keep records of their expenses. If they make a capital gain when they sell the property, the expenses (interest, insurance, maintenance costs and council rates) they couldn't claim as a rental deduction relating to their own occupation of the property are taken into account in working out their capital gain."
     
  16. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    But have you been audited?
     
  17. Comet

    Comet Member

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    Nope. I followed the rules and info provided by the ATO. I don't find it complicated, it's very obvious what they're saying. If we intended to stay in the property for six weeks over the Christmas holidays, then clearly that would be a problem. I'm completely clear on all this, my only question was regarding DV vs PC. And I've worked that out for myself. Thanks anyway
     
  18. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    You have to take your advice and make a call. You could use the ATO website to reduce any penalties if you are audited and the deductions are later denied so PDF a copy. But it is vague and it is not the law. the legislation is the only thing you can rely on.
     
  19. Comet

    Comet Member

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    I don't find it at all vague; it's quite clear and concise. I was planning on PDFing it all, yes. Not at all concerned. Was only looking for info on DV vs PC, but of course I can defer the loss over subsequent year/s, so DV is probably best.
     
  20. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    I love it when someone not qualified or experienced tells me what tax law says. If i had to compare it i would consider oncologists must wonder. Meh
     
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