Investing in a brand new property versus second-hand property: The Tax Depreciation perspective

It’s no secret that there are different strategies when it comes to investing in property. Some people prefer to invest in brand-new properties, while others opt for older property that they can renovate and resell for profit. Whilst depreciation should never be the reason behind an investment decision, recent legislative changes have altered which types of properties are eligible for depreciation deductions.

When announcing the Legislative Changes in 2017, the government stated that moving forward, they will “Deny income tax deductions for the decline in value of ‘previously used’ depreciating assets.”

What does this mean for investors? Let’s look at this in context. If you look at the table below, you’ll see a simplified net effect of the cost of owning an investment property broken down into three generalised scenarios:

  1.       A brand-new property;
  2.       A second-hand property built between 1987 and 2018; and
  3.       A property built before 1987.
PURCHASE PRICE

$750,000

Brand New

Property

Property Age

1987 – 2018

Property Built

Before 1987

Rent Received

@ $700 Per Week

$36,400 $36,400 $36,400
Interest @ 4% of

80% Borrowing

$24,000 $24,000 $24,000
Other Expenses

@ 1.5% (Rates, levies)

$11,250 $11,250 $11,250
Cash Surplus/Outlay Before

Depreciation

$1,150 $1,150 $1,150
Year 1 Depreciation Deduction – Building -$4,000 -$4,000 $0
Year 1 Depreciation

Deduction – Plant & Equipment

-$11,000 $0 $0
Total Taxation Position -$13,850 -$2,850 $1,150
Tax Refund @ 37% $5,125 $1,055 -$426
Net Income

(Net Outlay + Tax Refund)

$6,275 $2,205 $724
Cash income Per Week

(If a Positive Number, the Property is paying you)

$120 $42 $14

 

The assumptions are the same for each scenario: each property will generate a weekly rental income of $700 over a 52-week period, which works out at $36,400 per property.

Furthermore, the interest rate is 4 per cent for each property. Each scenario incorporates an LVR of  80 per cent of the purchase price ($750,000) – This equates to an annual interest expense of $24,000.

Each property will have other expenses – Assumed at 1.5 per cent of the purchase price, which is $11,250 annually. Granted, you could argue that property built before 1987 could have higher expenses, but for ease of comparison, we’ve kept the same rate.

So, it’s the same scenario for each property with the net outlay before depreciation of $1,150.

Now, here’s where things get interesting! What about the depreciation?

Note: Recipients of this email are entitled to a FREE estimate of the depreciation deductions available. If you own an investment property, new or second-hand, and haven’t had a depreciation schedule prepared, click here to request an estimate.   

 Depreciation on a brand-new property

You can see that the total tax loss on the brand-new property is quite high at $13,850. If you are an investor who is paying tax at a marginal tax rate of 37 per cent and you’re making a loss of $13,850, you will receive a tax cheque back from the ATO to the tune of $5,125 – and that’s cash in hand.

This amount, plus the $1,150 (Cash Surplus Before Depreciation) is $6,275. In this example, the property has been paying you $6,275 a year to own that property – so the net return is $120 a week positive cash flow.

Depreciation on an old property

Next, let’s look at the property built before 1987. Again, there is a $1,150 cash surplus before depreciation. In this example, you cannot claim depreciation on the previously used Plant and Equipment or on the original structure. So, here, you’ve actually increased your taxable income by $1,150. If you are in the 37 per cent income tax bracket, this equates to you paying an additional $426 in tax.

Given that you’ve made $1,150 and have then paid the additional $426 in tax for this, you are roughly $724 up per year. That’s around $14 per week you are making to own a property built before 1987.

Depreciation on a second-hand property built between 1987 and 2017

Using the same variables, if you bought a second-hand property built between 1987 and 2018, your annual tax loss would be $2,850, so you would receive a tax refund of $1,055 (providing you are in the 37 per cent bracket). Your cash surplus before depreciation was $1,150, so your annual surplus for owning the property is $2,205. That means your weekly cash flow a positive $42.

As you can see, from a depreciation perspective, there are pros and cons of buying brand-new vs older or almost-new properties. Again, whilst a property’s likely depreciation deductions shouldnt be the main reason for a purchase decision, depreciation certainly has a significant impact on an investor’s cashflow equation. 

Remember: To receive a FREE estimate of the likely deductions available to you on your investment property, whether new or old, click here!