Depreciation Schedules – Why do I need one?

This is the primary area in which Buying new investment property makes such a huge difference as there can be very large depreciation on a new property investment but virtually no depreciation on an old property investment.

The simple answer to the question is that a depreciation schedule (outlining the costs of all depreciable items) is a necessity and you must have one. The schedule is a one-off purchase (always organised by Lime Property Solutions for their clients at a very large discount) and the purchase is 100% tax deductible.

A Depreciation schedule is an accounting procedure for determining the amount of value left in a piece of equipment. There are several methods for calculating depreciation, generally based on either the passage of time or the level of activity (or use) of the asset. When a Quantity Surveyor completes an investor’s capital allowance and tax depreciation schedule, two main elements are generally included:

• Capital works deduction (division 43 – building materials) and
• Plant and equipment  (fixtures and fittings – division 40).

These two “divisions”, 43 and 42 are treated differently by the ATO.

Capital works deduction:

Also known as building write-off, this is a deduction available for the structural element of a building including fixed irremovable assets. Residential properties built after the 15th September 1987 are eligible to claim this deduction of 2.5% over the Australian Tax Office (ATO) specified life of the property – 40 years.

Plant and equipment:

The plant and equipment depreciation deductions are available for removable assets. Plant and equipment assets are identified through ATO legislation as assets which have a limited effective life and can reasonably be expected to decline in value over the time they’re used.

Depreciation benefits vary depending on the type of building, its age, its use and its fit out. Commercial, industrial and residential investment properties can all claim depreciation based on either the diminishing value or prime cost methods of depreciation. The prime cost method is the more common method to be used by your accountant for the average property investor as it allows acceleration of deductions in the first few years. It is very important to note that you can’t switch between methods of depreciation so it’s always best to consult with your Accountant to work out the best method to suit your investment strategy.

A rental guarantee on your new investment property, usually given by the developer or for a certain period of time) can sound very attractive. Guarantees are usually used quite liberally in a housing market that is heading towards oversupply and is not looking too attractive to the property investor based on the specific market’s own merits. For example, now in 2017, the inner-city Melbourne apartment market and in Brisbane rental guarantees are the norm on new investment units, because finding tenants is getting tougher and rentals are on the way down. 

Rental guarantees usually have strings attached. The cost of the guarantee can be factored into the purchase price, the old adage, and “There is no such thing as a free lunch!”. In effect property investment buyer is paying the developer upfront for the rent he will repay you over the next few years. Not all guarantees are like this.

 A “no vacancy” guarantee is a more genuine assistance sometimes offered by good developers. In this case, the developer is recognising that it may significantly affect the cash flow of prospective property investment buyers if their new investment property lies vacant for a number of weeks, (which can be common in larger new developments as the mangers seek a very large number of new tenants over a short period of time). To avoid this, the developer will offer to pay (usually at current market value) the rent until such times as the first tenant is found or for a period up to (usually) around 12 weeks. It appears to be a more ‘honest’ way of assisting investors in that they are not being offered an inflated amount of rental which has already been added to the purchase price, but are being given a more genuine ‘assistance’ with any possible cash flow issues at the time of purchase.

So, in summary; If you come across a property marketed with a rental guarantee, tread carefully. Guarantees were traditionally associated with government supplied housing, such as Defence Force Housing, they are becoming more commonplace in private developments   offering guaranteed yields of 6% or 7% for up to three years. These yields are usually quite unattainable in the real market.

The guaranteed rental is usually already factored into the initial purchase price of the property which, in some but not all cases may over-value the property. When the guarantee period is over, the rent you can realistically achieve will often be far less.

No vacancy guarantees are usually a better and more accurate option and are often provided as a more genuine commitment from the developer to assist the buyer overcome any initial cash flow problems which may occur if it takes slightly longer than anticipated to find a first tenant.

Lime Property Solutions will not give advice on this matter. This is a discussion you should have with your Broker or lender. However, for anyone who is concerned about fluctuating interest rates or rising interest rates in particular, it is by far one of the best ways of securing cash flow in the future. Even fixed rates of up to 10 years are currently less than variable rates of a few years ago.

On a personal note, I have fixed rates recently for the first time in my life. I’ve been examining the fact that some 2 year or even 3 year fixed rates are already over 2 interest rate cuts lower, (that is 0.25% + 0.25%), than the current variable rate. The question to me then becomes, “Even if interest rates should collapse over the next 2 years, would I be comfortable and happy paying 4.18% on these fixed loans?” My answer was ‘yes’.

A final inspection is not necessary but we would suggest that anyone who opts to pay for a new investment property without ensuring that all is in order and it has been built properly is probably a bit mad!

Lime Property Solutions will always assist in putting you in touch with very reasonably priced hand over experts. These companies will do a very thorough inspection of your new investment property for a small fee and give you a full report of what needs to be done, then ensure that the property is perfect before you settle. Even if you are in a position to do a final inspection yourself, we would still recommend the use of a professional company to do the final handover inspection on your behalf.

Property & Borrowings in an SMSF

You can buy direct property within your superannuation fund.

One of the biggest advantages that having a self-managed super fund (SMSF) offer, is the opportunity to invest in property.  New legislation was introduced in 2007 that permitted borrowings to occur within self-managed super funds to invest in direct property.

If you don’t have sufficient funds in your superfund to buy a property outright it is now possible for your SMSF to borrow funds for property investment if structured in accordance with the ATO’s requirements. By taking control yourself with appropriate advice you can maximise your potential retirement benefits.

It is essential to seek out advice from a good solicitor and often a financial planner before going down the track of buying investment property in your SMSF. Generally, there should be more than $150,000 in the SMSF before even first considering an investment property. Your fund can usually only borrow a maximum of 80% of the purchase price so the fund has to pay 20% plus stamp duty and other costs. Some types of property investment purchase are not suitable for SMSF’s.

You should talk to Lime Property Solutions, about the right way to structure your SMSF before you do anything else. They can have a discussion then put you in touch with the necessary good professionals who will assist in making sure you have a compliant fund.

This is actually a tax minimisation strategy which may be recommended to clients with lump sum funds towards the end of a financial year. Sometime referred to as “creating an obligation” the strategy involves paying the interest that will accumulate in advance on a property investment loan over the following tax year before it is actually charged.

This allows you to claim the costs against your current tax year (the year the interest was paid. In almost all cases, this must be approved by your lender before proceeding. Some lenders may even offer a small discount on the interest rate if you do pay in advance. Full documentation of the bank transaction must also be given to your tax advisor before a claim can be made.

Conveyancing is a term that refers to the transfer of ownership of a property. This legal process is normally carried out by a conveyancer or solicitor to handle this process on the buyer’s behalf.

It is possible to act on your own when making a property purchase but the process of documentation and settling can be complicated is quite daunting without training and experience. Bringing in support from an expert who is familiar with legal documents and legislation can make the process easier and take away a lot of the risk.

It is very important to realise as a property investor that Australia operates a Federal System of government which means that the laws are different for conveyancing in each state. If you are purchasing an investment property inter-state, it is important to ensure you are working with a conveyance/solicitor, qualified to do the work for you and not someone who is likely to work as a ‘middle-man’ while the real work is done by someone else in the state you are purchasing the property investment.

Lime Property Solutions will always be in a position to recommend a good conveyance in your area, qualified to do the work for you.

Once a conveyance is appointed, they will be responsible for a number of tasks as they help you through the settlement process. These jobs include acting as a liaison between you and your lender’s solicitor, checking your contract of sale, performing title searches and acting as your legal representative for the transaction.

Your conveyancer will also check on a number of important things for you, including whether there are any outstanding out-going costs on the property – such as council rates or taxes or water payments or outstanding strata/body corporate fees. In many cases, a conveyancer will also check over loan documents for you.

The cost of hiring a conveyancer can differ from state to state – and even from transaction to transaction, depending on the amount of time and work involved.

It is important to enquire about fees before you agree to appoint anyone.

Cross collateralisation is a finance structure where a single lender is used to finance multiple properties you own. This allows the lender to secure one property against the value of another in the portfolio, thereby tying the two assets together, financially. A cross collateralised structure benefits the lender by providing it with greater security should you fall into financial hardship or try to manipulate the portfolio by purchase or sale of any properties.

The BIG Misconception!

There is much misinformation in the public perception about ‘protection’ that can be achieved by not cross-collateralising the home with an investment. The belief seems to be that if something goes wrong with the investment, then the home will be safe. This is an absolute nonsense. In Australia, if you owe money, especially to one of our major lenders and you have assets, be it your home or your car or any other significant asset, then you will go through a legal process until the debt is paid. In other words, do not believe that by avoiding cross-collateralisation you are also avoiding any possibility of losing your home should anything go wrong in the future!

Most new home construction these days are done by property developers who acquire land when it’s released by the government. The developers lay down infrastructure (roads, utilities, water and sewage), then either:

1. Build homes and sell them as a complete house and land deal

   or

2. Offer a number of standard or customisable home designs, so that you can choose the block of land you want and the features you’d like in your new home. House and Land Package

A potential benefit of buying your new home or investment property this way is that you can ensure you get a property that suits your needs.

As an investor in property, a major benefit in buying house and land is that you will only pay stamp duty on the value of the land only. This can save thousands of dollars on initial costs.

House and land packages are often tailored to appeal to specific groups of buyers. You might find the one you want in a golfing estate, retirement village or even an eco-village. Then there are the new sub-divisions, usually creating a great opportunity for the property investor.

Is buying a house and land package purchase any different to buying a house?

Financing for a house and land package usually consists of two steps: buying the land then building the house. The loans can be arranged separately, but are usually bundled together.

Buying the land is a standard real estate transaction with a regular mortgage. The second step requires a construction loan where you ‘draw down’ an agreed amount to pay for each stage as your home is built. That way, you only pay interest on the money you’re using at each stage.

A good Broker, such as those recommended by Lime, will make a very significant difference to your investment up front by structuring the construction loan in such a way that you will benefit greatly from the type of loan a normal lender is likely to offer which will almost certainly be just cost plus stamp duty plus legal costs. More can be done in structuring your investment construction loan.

Other considerations

As an investor, make sure you are fully aware of all inclusions. In most cases for property investment a full turn-key property (fully finished with window coverings) with landscaping, fences and driveways included in a FIXED PRICE contract is most desirable.

LMI insures the lender, NOT the borrower. The insurance covers the lender of any shortfall should the borrower default on the mortgage repayments and the property can end up being sold for less than the outstanding loan balance plus some costs. Do not confuse LMI as a ‘Mortgage Protection Insurance’, which covers your repayments should you die, lose your job or become incapacitated.

The borrower must realise that it is the borrower who is paying for the insurance policy, even though it is the lender who benefits. Borrowers pay the premium for the insurance up-front either from cash deposit funds or more commonly, by adding or ‘capitalising’ it into the loan, meaning it can be payed off as part of normal mortgage repayments.

It is really important to understand the real lack of cash flow implications an LMI can have on an investment loan. As the LMI is usually capitalised against the new investment loan then even a $10,000 LMI at an interest rate of 4.5% is only going to add an additional $450 gross per annum on to investment property holding costs. On the top marginal tax rate this would reduce to a $229 per annum net cost. This is just over 6c per day additional cost on a properly negatively geared property investment – hardly a reason to walk away from a property with a great growth potential!

The cost of LMI varies according to deposit size, loan size and type.

As an example: buying a $500,000 property with a $50,000 deposit, resulting in only 10% equity and a loan-to-value ratio (LVR) of 90%, would mean at current rates with a standard loan, the LMI costs could be around $8,000.