Does Depreciation Affect Capital Gains Tax? (Ep256)
Claiming depreciation can offer major tax benefits to property investors. But does depreciation affect capital gains tax? It does and here’s how.
Does depreciation affects capital gains tax? If you’re claiming depreciation on your property, when it comes time to sell your property, how does that depreciation affects the capital gains tax that you’re going to pay? Does it increase the capital gains tax or does it decrease the capital gains tax? Well, that’s what we’re going to cover in today’s episode. Does it affect depreciation? Does depreciation affect capital gains tax? It is yes that it does. And I’m going to explain it in more detail.
First let’s have a look at what capital gains tax is. Capital gains tax is a tax you pay on capital gains. Therefore capital gains equal your capital proceeds minus the cost base of the property. Capital proceeds is the sale price of your property minus the expenses of selling that property. Things like paying the agent commission and stuff like that. And then your cost base is the cost of buying the property plus the expenses that come with buying that. That might include legal fees or it may include stand stamp duty. You just need to check with your accountant on these. I just want to make clear and put a disclaimer out that I’m not a taxation accountant and so you should always speak to an accountant before you do anything tax-related.
The capital proceeds or the sales price minus the cost base or the purchase price of the property is what capital gains is. If you got a profit out of that then you need to pay tax on that. So, that’s what capital gains is in a nutshell.
Depreciation affects your cost base. To recap, capital gains is capital proceeds minus the cost base. So if the depreciation is affecting the cost base of your property so it’s what you paid for it minus your expenses. There are two types of depreciation and these affect your cost base in different ways.
The building depreciation lowers your cost base. When you’re claiming depreciation on the building structure itself that actually lowers your cost base over time. You’re claiming that as a loss and therefore your cost base is becoming smaller and smaller as you’re claiming those losses because the cost base is the value of what you purchase the property for and if the building is going down in value then that cost base is getting smaller.
Plant and equipment depreciation can lower or raise your cost base. It really just depends on the situation. If you have plant and equipment, what you need to do…. Plant and equipment, just so you know is things like your fixtures and your fittings and you carpet and all of that sort of stuff. But basically what you need to work out is what was the total value of the plant and equipment when you purchased the property and what’s the total value of the plant and equipment when you sold the property. And basically you minus the plant and equipment from when you sold it from the plant and equipment from when you purchased it. So if you purchased it and it’s worth $20,000 dollars and it’s gone down 50% and it’s now worth $10,000.00, then it’s now worth $10,000 less and so therefore it would lower your cost base. Let’s say that you done some renovations and you put in a new dishwasher and a new kitchen and all of this sort of stuff and your cost base has actually gone up from $20,000 to $40,000 you actually have a $20,000 rise in your cost base and so that would add to your cost base.
Now, this is all a bit confusing and this is why we hire quantity surveyors and I encourage you to get in contact with a quantity surveyor. I recommend BMT which you can find at BMT QS. They do quantity surveys all over the country. I interviewed Brad who is the CEO, a great guy and they know what they’re doing.
Therefore basically the lower your cost base means the more capital gains you have. The lower your cost base the greater the difference between your cost base and your capital proceeds is going to be, means the more profit which means more capital gains tax. Again I’m just showing you on the screen here that that capital gains tax is based on the capital proceeds minus the cost base.
In most circumstances depreciation will add to the capital gains tax that you have to pay. So, is it worth actually claiming this at all? Or should you just not claim depreciation? Well for most investors they are going to want to claim depreciation. I suggest speaking to an advisor if you want to know about this issue. But most investors feel that it’s better to claim the depreciation now rather than to save on capital gains tax at a later date. The reason for this is that it improves your cash flow now. So your cash flow can be greater because you’re saving money which means you’re paying less tax or you’re getting your tax refund. So it improves your cash flow situation and gives you extra money to reinvest and grow your portfolio.
So if you wait until you’re saving it on capital gains tax, well you might go twenty years without ever seeing a dime of those savings. However if you’re claiming it now you can get those instant savings straightaway and use those savings to reinvest and grow your portfolio faster, so hopefully when it comes time to sell, the extra capital gains tax you have to pay is menial compared to the size your portfolio in the future.
If you want to learn more about depreciation and how to fix capital gains tax and how you can claim depreciation to better improve the profitability of your investment portfolio then I’ve done a full series on it with Brad who’s the CEO at BMT which is the largest quantity surveying company in Australia. So go to www.onproperty.com.au/depreciation to see my ten-part series absolutely free on depreciation over there.
So until tomorrow stay positive!