Expert Bust #7 - Avoid High Depreciation Properties

There's no such thing as depreciation "benefits". Depreciation isn't beneficial, it's the opposite of appreciation.

If you can claim $10k in depreciation and you're on a 40% marginal tax rate, you'll pay $4k less tax. That doesn't mean you're better off by $4k. You're actually worse off by $6k. If your property didn't depreciate at all, you'd be better off by $6k.

Claim every cent you can, but don't go looking for properties with big depreciation claims.



The chart plots the estimated capital growth relative to the degree of depreciation. The orange dotted line estimates the relationship between depreciation and capital growth. The chart assumes a baseline capital growth rate for land of 8%. That’s the growth rate of vacant land which has nothing to depreciate.

More details can be seen in the full article which is topic #7 of the Expert Busting series on the Select Residential Property website.

 

Very good, thank you.

Yes, real estate investing is a tug of war between the appreciation of the land, and the depreciation of the building. Depreciation isn't a tax concept - it literally means a reduction in the value of the asset.

Good insight, and well said.

 

Remmber that depreciaiotn reduces the cost base for CGT purposes too, so if you sell for a capital gain, there is effectively a claw-back of the depreciation gained.

In some cases, if you qualify for the 50% CGT discount (held in own name for > 12 months plus other factors), then there is some benefit as only half the depreciation is clawed back.

 

I have a different view.

Let’s say one owns two identical properties, A and B, that are on identical blocks next to each other.

A is one’s PPOR, B is an IP.

Both properties deprecate the same amount each year. Depreciation of A is not deductible; depreciation of B is.

So B’s depreciation can be used to reduce one tax payable and potentially results in a tax refund, increasing one’s cashflow.

For me, that is a “benefit” of B over A.

In accumulation phase, I have a preference for high deprecating IPs over low/nil depreciating IPs, for this very reason.

 

I dont consider this when buying, but when developing property its a bonus if holding

 

Kierank, are you talking about depreciation benefits that you generate yourself via renovation and improvement? Or depreciation benefits that you buy via the purchase of newer properties?

 

Let's say you invest in an identical property C but in the land only ...the building is owned by the tenant .
No depreciation for C as land only
I would rather invest in land only with no depreciation.
The tenant can keep all the depreciation "benefits" I will keep land with no "benefits".

 

Both

 

Good point Hamish. If you decide to sell, the tax savings are clawed back by the ATO anyway. The full article has more on this.

 

Plenty more tax deductions not claimable for PPORs. Interest on the mortgage, council rates, repairs and maintenance "benefits", lol.

 

... and, for a B+H investor like me, a dollar claimed in depreciation today is worth more than a dollar clawed back in 40, 50, 60, ... years time.

My parents bought a property in 1969 for $16,000. After 50 years of depreciation (not claimed as it was their PPOR), it is now worth $350,000.

Hence, one should claim every dollar of depreciation now and enjoy the benefit of time on that dollar until they sell.

 

Yes cash flow is about the only benefit to high depreciating properties. But at the detriment of overall net wealth. If you claim $10k in losses and pay $4k less tax, your not better off by $4k your worse off by $6k. Unless you're ONLY consideration is cash flow.

 

I am missing the point of this post. Please explain.

 

So there is a benefit of depreciation?

If PPOR, net worth is reduced by $10k but if IP, net worth is only reduced by $6k.

Is that another benefit of depreciation?

 

Oh yeah, claim every cent you can.

Whether to sell or hold after developing is an interesting equation. You have to compare appreciation of the land against depreciation of the dwelling. Then compare that estimate with the opportunity costs of where else your equity could be invested. And finally calculate the costs of selling and buying elsewhere. Tricky, but possible.

 

Yeah agreed, so we don't "invest" in PPORs. Plus all the other tax benefits of investment properties over PPORs.

I think where investors get mucked up is not realizing that depreciation is a loss as John pointed out so clearly.

There's no repairs and maintenance "benefits" term in the investment industry. The term "benefits" is a misnomer that has confused a lot of investors.

It's a marketing ploy by those who sell new. And those are the most vehement objectors to my posts on this topic and Expert Bust #3 about new vs. old.

 

I won't claim to be unbiased here, but half of the savings are clawed back, given the 50% CGT discount most people can apply. There's usually a net benefit in that regard too.

 

right
Its a no brainer for me as I will hold all and they are cash flow positive and will access equity and reinvest funds. Depreciation a nice bonus today.

 

Does this mean that purchasing land has the best ROI? So why don't investors just buy land all the time? Is it because of the holding costs and there being no rental income? But the growth is so good! I know a guy who purchased land in Rouse Hill for $150k in 2011 and sold it 7 years later for $900k - good example.

 

1: difficulty in finding fully leased land only properties
2: in times of falling properties these properties fall more than other properties
3: rentals are generally fixed for longer periods so if interest rate rises there is no ability to increase rentals 4: in some countries there are land taxes which may not not be recovered
5: there are unhappy lessees who hold a depreciating asset.
6: temption is high to sell.
7: this model is hard to sell in times of low interest due to the rental calculation model

Ps the model I use has "rental income" NOT Is it because of the holding costs and there being no rental income?