10 The truth about depreciation

Question 1

What happens to a new car’s value when it is driven off the showroom floor?

Answer 1

Its value immediately diminishes by several thousand dollars.

Question 2

What is depreciation?

Answer 2

An accounting term used to describe the way an asset falls in value due to wear and tear.

Question 3

How should the cost of a carpet that lasts 10 years be allocated?

Answer 3

The $7500 should be spread over the entire 10-year lifespan.

Question 4

What principle does accounting apply to match income with costs?

Answer 4

The matching principle.

Question 5

Does real estate depreciate?

Answer 5

Land does not depreciate, but buildings do.

Question 6

What causes houses to depreciate in value?

Answer 6

Wear and tear of internal fixtures and fittings and weathering of the exterior.

Question 7

Can investors claim an income tax deduction for capital purchases?

Answer 7

No, they can write down the cost over the item’s working life.

Question 8

What is the annual capital works deduction rate for residential rental properties built after 17 July 1985?

Answer 8

2.5 percent per annum against the construction cost.

Question 9

What qualifies for a capital works deduction?

Answer 9

New buildings, extensions, alterations, or structural improvements done after 17 July 1985.

Question 10

What is the depreciation method that gives equal deduction over the asset’s useful life?

Answer 10

Prime cost method.

Question 11

What is the depreciation method that gives more deduction in early years?

Answer 11

Diminishing value method.

Question 12

Items costing $300 or less can be _______ in the year they are bought.

Answer 12

fully depreciated.

Question 13

Can you claim a capital works or depreciation tax deduction if a previous owner paid for improvements?

Answer 13

Yes, it is assumed the cost is reflected in the purchase price.

Question 14

What is the cashflow impact of purchasing a $7500 carpet in year one?

Answer 14

An outflow of $7500.

Question 15

What is an unexpected bonus regarding tax deductions?

Answer 15

You don’t have to be the one who paid for improvements to claim a deduction.

Question 16

What can help you prove the value and date of capital works from a previous owner?

Answer 16

Engaging a quantity surveyor.

Question 17

What is the effect of capital works deductions on capital gains tax calculation?

Answer 17

They are subtracted from the purchase amount, increasing the gain.

Question 18

What happens to depreciation recouped upon selling the property?

Answer 18

It is treated as income on your tax return under a balancing charge.

Question 19

What is the cashflow loss in Sally’s investment property example?

Answer 19

$1770.

Question 20

What tax savings did Sally achieve after using her deductions?

Answer 20

$2,832.

Question 21

What is the purpose of depreciation in relation to tax?

Answer 21

It provides a temporary tax benefit by deferring some tax to a later date.

Question 22

What is the capital works deduction amount claimed by Andrew for a building worth $125,000?

Answer 22

$3125.

Question 23

What type of property improvements can qualify for capital works deductions?

Answer 23

Carports, garages, and major renovations.

Question 24

What is the annual depreciation deduction for Brian’s new shed costing $8000?

Answer 24

$200.

Question 25

What is a capital gain?

Answer 25

$1,875 ## Footnote Capital gains refer to the profit made from selling an asset for more than its purchase price.

Question 26

What is a balancing charge?

Answer 26

Income on your tax return that results from recouped depreciation ## Footnote Balancing charges occur when previously claimed depreciation must be repaid upon selling an asset.

Question 27

How is recouped depreciation treated on your tax return?

Answer 27

As income under a balancing charge ## Footnote This means it is added to your total income when calculating taxes.

Question 28

What happens if you don't specify the selling price of fixtures and fittings?

Answer 28

You will have to repay any depreciation claimed ## Footnote The assumption is that the sale price equals the original purchase price unless specified otherwise.

Question 29

How can you optimize your tax outcome when selling property?

Answer 29

Specify separate amounts for land, buildings, and fixtures in the sales contract ## Footnote This helps to increase capital gains while minimizing repayment of depreciation.

Question 30

What is the effect of separating fixtures and fittings on taxable income?

Answer 30

Reduces taxable income by $2,500 ## Footnote This strategy allows for a better tax outcome without reducing actual income.

Question 31

What is the main takeaway regarding depreciation?

Answer 31

Depreciation allows for tax deferral, not tax saving ## Footnote It is essential to understand that while depreciation can reduce taxable income temporarily, it does not eliminate tax liabilities.

Question 32

What is a common mistake related to depreciation and asset replacement?

Answer 32

Failing to set aside cash reserves to replace aging assets ## Footnote This can lead to financial difficulties, as seen with Ansett airlines.

Question 33

What should investors be wary of when it comes to depreciation?

Answer 33

Properties that rely on depreciation to appear cashflow positive ## Footnote These can mask underlying financial issues and may require continuous work to offset tax liabilities.

Question 34

What is a recommended approach for real estate investment?

Answer 34

Focus on genuine positive cashflow and depreciation benefits ## Footnote This helps to avoid marginal deals that less skilled investors might pursue.

Question 35

What is depreciation?

Answer 35

An accounting term describing how an asset’s value decreases with use ## Footnote It reflects the wear and tear of the asset over time.

Question 36

What should you do to find out about potential tax deductions?

Answer 36

See how much capital works and/or depreciation you may be entitled to ## Footnote You might discover significant tax deductions that you were previously unaware of.

Question 37

What should be specified in the sales contract when selling property?

Answer 37

Separate amounts for the house and land and for the fixtures and fittings ## Footnote This helps to optimize tax outcomes and clarify the transaction.

Question 38

What analogy is used to describe cashflow and depreciation in investing?

Answer 38

Cashflow is the meat and potatoes; depreciation is gravy on top ## Footnote This highlights the importance of cashflow as the primary focus of investment.

Question 39

What is the importance of consulting with an accountant?

Answer 39

To clarify issues regarding depreciation and investment strategies ## Footnote Accountants can provide tailored advice based on specific situations.