How to improve cash flow as a property investor through the building allowance

When choosing to invest in either an old or new property, an investor should consider the overall depreciation benefits, including the potential benefits of depreciating the bricks and mortar of a newer property.

Choosing to buy newer property has benefits that extend beyond having less maintenance and repair issues. One of the best cash flow secrets of the professional investor is a little known tax concession that takes advantage of new construction – The building allowance. The building allowance offsets hard construction costs of the property against the investor’s assessable income.

The building allowance acts as a non-cash deduction where the ATO allows the owner of an investment property to claim the wear and tear of a building structure over time. A non-cash deduction is when an investor can make a claim on an item without spending any money directly on the items. These allowances mean construction costs, such as concrete and brickwork can be used to counter an investor’s overall income.

If the building was built after 15 September 1987 than half of the purchase price is claimable at a rate of 2.5 percent per annum. For instance, if the property purchased was valued at $500,000, then $6,250 is deductible as depreciation each year. Engaging with a quality surveyor to assess the building will enable them to provide you with reliable figures for your tax depreciation schedule, enabling you to maximise your tax position and overall cash flow.

1Source: http://www.realestate.com.au/advice/property-depreciation-101/

Compiling a depreciation schedule will help you understand how much you can successfully claim per annum and identify where you can reduce your taxable income. The idea is to help you pay less tax, however it is best to avoid an overly aggressive depreciation schedule and stick to the guidelines provided by the ATO. Otherwise you may find yourself being audited and losing your entire return. Don’t forget that the surveyor’s fees are 100 percent tax deductible.

Why does the government offer the building depreciation allowance?

It is in the Federal Government’s interests to incentivise the purchase of new property for two reasons:

  1. New property adds to the housing supply. Every time a block of units is constructed, more people have a place to call home, thereby reducing the pressure on the available supply of properties to rent.
  1. Construction is an economic stimulus to the economy. The construction of units has a multiplier effect on the economy. Construction means that building trades will be engaged. The small businesses that support these tradesmen will be engaged. And when the dwellings are completed, sold, leased, furnished and so forth, a number of other businesses will be engaged.

By offering a building allowance on the bricks and mortar of a new investment property, the government has significantly improved the cash flow of holding a new property, hence incentivising it for investors. Ironically, it can sometimes be easier to hold a new yet more expensive property than an old, cheap second hand property!

Should I buy a property built just after 1987 or buy a brand new property?

It stands to reason that a property bought today is going to cost a lot more than a property constructed in 1987.

A qualified professional such as a quantity surveyor will estimate the costs of the building in the year it was built, for example 1990. Hence, you will get 40 years of cash flow deductions from a base line of 1990.

Alternatively a building constructed this year will have a building allowance deduction much higher than the one in 1990 as the costs of the construction are much higher.

Lets use an example of a property purchased in 1990 for $150k. Roughly half of the purchase price is made up of building costs, i.e. $75k. For the next 40 years, you will get 2.5% depreciation on $75k, which equates to $1875 pa.

Fast forward to 2016 when you have purchased a brand new property for $700k. Roughly half of the purchase price is made up of building costs, i.e. $350k. For the next 40 years, you will receive 2.5% depreciation on $350k, which equates to $8750

In this case, the difference in cash flow between the two acquisitions is $6875 pa. Often this amount back will mean the property becomes positively geared, a surefire way to put money in your pocket. How good is that!

Its clear the building allowance deduction ensures you will get more cash flow from a new property constructed today.

To find out more about the building allowance contact me on 02 9522 3000.

This article is the third in our article series – Cash flow secrets for property investors. Watch this space for more great tips!

 

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