If you’re not already aware, ‘effective life’ is the term the Australian Taxation Office uses when talking about how long an item is generally viewed to last. For rental property purposes, this will affect you in a couple of ways – firstly, this will be the number of years over which you can depreciate an asset, and secondly, when making a claim against a tenant for damage, the remaining effective life of the item needs to be taken into account. (For more detail on this aspect, see our article ‘Tenant Damage Claims’).
Unless your property is near-new, chances are you’re spending some money each year on maintenance. And for newer properties, you should be looking ahead to what might need replacing soon and budgeting for it to be done (in an ideal world where life’s unexpected expenses don’t keep getting in the way!) But part of this planning should include the effective life of the various items in the property, as well as your general feeling about whether for example you should replace the carpet when your current tenant moves out, or whether it could last another 2 or 3 years.
In some properties, such as a small unit or villa, it’s quite feasible to do a major renovation once everything’s looking a bit tired but for larger properties and investors who are looking to tackle big expenses one at a time it makes sense to complete improvements each time the property is vacant, or at least every 2-3 years. You’ll reduce the time that the property is off the market and stop it reaching a point where you can’t ask as much rent because of the property’s appearance.
Maximising Your Depreciation Claim
The amount you claim on each item will reduce each year as it wears out and its value goes down. Once an item has reached its effective life span, we’ll use the carpet example again which has an effective life of ten years, you can replace it and be able to start claiming depreciation from the maximum value again. Plus, if you replace an item that still has some depreciation remaining on it, you can claim all of the residual depreciation in that year’s tax return. (see note)
Knowing that you can dramatically increase the depreciation deductions by replacing items that have reached their effective life span will help you to continue to reap the maximum financial benefit from your investment.
Planning Your Spending
Using the effective life enables you to budget for replacing flooring, repainting, installing new bathroom or kitchen cabinets or replacing light fittings according to when these items will no longer be working for you tax-wise. With the different effective life spans of each (see below) you should be able to make improvements to your property between leases without requiring the property to be off the market for a full renovation, without needing to spend tens of thousands in one go, and without the property becoming too tired over time to be earning you top market rent.
You can also decide what will provide more value to you, for example installing new carpet or instead replacing the carpet with a floating timber floor, based on how many years of depreciation claims each one will give you and how much you can claim for each of those years (this is where specialist advice comes in!).
And if your property is already in that class that we agents like to call ‘original’? Contact a depreciation specialist and find out what you could claim for scrapping the old items and the potential tax deductions you could make by renovating.
Common Items and their Effective Life
Carpet and vinyl 10 years
Floating timber floor 15 years
Removable light shades 5 years
Stove, cooktop, oven 12 years
machines and clothes dryers 10 years
Refrigerators 12 years
Evaporative coolers (excluding ducting and vents) 20 years
Note: Tax issues are complex and a range of factors need to be taken into account, including the age of your property, whether it’s been rented out prior to renovations/repairs taking place, when you have your depreciation report completed, and more. This article is intended as an introductory guide only and is based on using the Diminishing Value method of depreciation, which may not be the best approach for all investors. We recommend that you speak to your accountant and a depreciation specialist prior to undertaking any renovations or repairs. We recommend BMT Quantity Surveyors – 1300 728 726, www.bmtqs.com.au