Everything You Need to Know About Commercial Property Depreciation Eligibility

When it comes to commercial depreciation, the Australian Tax Office (ATO) has provisions that allow for depreciation deductions on commercial properties. So, this tax advantage isn’t limited to those investing in residential properties. 

In fact, both commercial property owners and tenants can access these tax benefits. This sets commercial depreciation apart from residential depreciation, where typically only property owners can claim deductions. 

So, here’s a breakdown of how commercial depreciation works and how you can benefit.

What is Commercial Property?

Commercial property is an investment avenue where the primary aim is to generate rent from tenants operating businesses. This means property investors who buy commercial property earn their income from renting it out to commercial entities. 

Examples of commercial buildings include the following: 

• Warehouses
• Restaurants
• Offices
• Shopping centres
• Medical practises

How Does Commercial Depreciation Work?

Just like with residential buildings, as the commercial building gets older, it depreciates. This means that its structure and the assets within the building are subject to general wear, and so the value decreases. 

There are two main types of commercial depreciation deductions.

Division 43: Capital Works Deductions

Capital allowance deductions pertain to the depreciation of the building’s structure. Typically, commercial property owners can claim depreciation if the building was constructed after July 20, 1982.

Division 40: Plant and Equipment (Depreciating Assets)

“Plant and equipment” or “depreciating assets” refer to the fixtures and fittings inside the building, ranging from light fittings and carpets to machinery like refrigerated storage units. The ATO determines the depreciation rate for these assets based on their value and lifespan (also known as the asset’s effective life).

Who Can Claim Commercial Property Depreciation?

The ATO permits both commercial property owners and tenants to claim depreciation as a tax deduction, provided the property generates income. 

Owners can claim for the building’s structure and any assets they own within. Tenants, however, can claim tax depreciation for assets they purchase and install during a fit-out.

What is a Fit-Out?

Once the commercial tenant’s lease begins and throughout the duration of the lease, tenants can claim depreciation for any assets that they add to the commercial building. For example, if you add an air conditioning unit and a security system to the commercial property that you’re leasing, you’re entitled to claim depreciation on those assets. 

Other fit-out examples include: 

• Carpet
• Fire fighting equipment
• Desks and shelves 
• Vinyl flooring
• Blinds

The same applies if you undertake any construction work on the commercial property that you’re leasing; the ATO will allow you to claim depreciation deductions for the construction costs. 

Note, however, that if a commercial tenant vacates the property and doesn’t remove the fit-out, the owner of the commercial property may be able to claim the remaining property depreciation for the items, unless the lease conditions stipulate otherwise. 

For example, the commercial lease may stipulate that all the fit-outs must be returned to the tenant in their original condition at the end of the rental period.

How is the Decline in Value Calculated?

Depreciation varies based on the type of commercial property. The ATO has set specific depreciation rates for different commercial buildings and their construction dates.

Commercial Property Depreciation Case Study

Milly purchased a commercial property in Bondi Beach in February 2022. The property is best suited as a restaurant space. 

After having a Quantity Surveyor assess the property, the following was established: 

• The property was built in 2007
• It had tiled flooring, and
• There was a small kitchen area with marble benchtops

After purchasing the property, Milly decided to fit out the property with two more air conditioning units—one in the restaurant area and one in the small back office. She also installed some basic kitchen appliances. 

The total cost of the fit-out was $11,360. (Division 40 – items depreciation at individual rates based on effective life span)

In June 2022, Milly entered into a commercial lease with Marcus, who wanted to turn the space into a small vegan cafe. 

Before opening his cafe, Marcus installed a few more essential cooking appliances and utensils and brought in tables and chairs, as well as all the necessary cutlery, crockery, and glassware. 

The total cost amounted to $31,000. (Division 40 – as detailed above)

As the owner of the property, Milly can claim a commercial property tax depreciation deduction for the following items: 

• Capital works of the building
• Capital works of the marble benchtops
• The tiled flooring
• The two new air conditioning units
• The newly installed kitchen appliance
• Existing plant and equipment assets

If Quantity Surveyor assess the property construction for $1.2 million, her yearly depreciation calculation would be as follows: 

$1.2 million x 2.5% = $30,000 (Division 43 depreciation)

Milly can continue claiming a tax depreciation deduction under Division 43  amounting to $30,000 each year until 2047, provided that she still owns it and that it is used for income-producing purposes. In addition Milly can claim the items under Division 40 at varying rates each year

As the tenant of the property, Marcus can claim commercial property depreciation deductions under Division 40 for the following:

• Kitchen appliances and utensils
• Restaurant furniture
• Cutlery and crockery
• Glassware

What is a Commercial Property Depreciation Schedule?

A property depreciation schedule is a report that details the tax depreciation deductions you can claim on your investment property. However, to claim these deductions, you need to identify the value of a property and all its fittings and fixtures. 

The purpose of a tax depreciation schedule is to outline the value of both your Division 40 and Division 43 assets as well as how much it has depreciated and will depreciate. 

This will give you a clear idea of how much you can claim. 

It’s not just important to property investors, though. When leasing commercial property, you should organise a tax depreciation schedule for the depreciation on your new fit-out and on any equipment that you’ve installed.

Key Takeaways

• The ATO offers depreciation deductions for commercial properties, benefiting both property owners and tenants.
• Depreciation is categorised into Division 43 (relating to the building’s structure) and Division 40 (pertaining to fixtures and fittings inside the building)
• A depreciation schedule is a tool that details the tax deductions available for commercial properties, aiding in claiming the correct tax benefits.

If you need help identifying the depreciation potential of your commercial investment property, contact us today. 

FAQs

What’s the Difference Between Division 43 and Division 40?

Division 43 pertains to the building’s structure, while Division 40 relates to fixtures and fittings inside the building.

Can Tenants Claim Depreciation on Commercial Properties?

Yes, tenants can claim depreciation for assets they purchase and install during their lease.

How is the Depreciation Rate Determined?

The ATO sets specific depreciation rates based on the type and age of the commercial building and assets.

What is the Significance of a Commercial Property Depreciation Schedule?

It helps owners and tenants understand the tax deductions they can claim on their property, maximising their benefits.

What Depreciation Methods Can You Use?

There are two depreciation methods.

Diminishing Value Method:

• This method accelerates the depreciation expense in the earlier years of the asset’s life.
• Each year, the depreciation is calculated on the remaining (diminishing) book value of the asset. As a result, the depreciation expense is higher in the initial years and decreases over time.
• This method is suitable for assets that lose value quickly in their early years, like certain types of machinery or technology.

Prime Cost Method:

• This method spreads the depreciation evenly over the asset’s useful life.
• Each year, the asset depreciates by a fixed amount, which is calculated based on the asset’s initial cost and its expected useful life.
• This method provides a consistent, straight-line depreciation expense each year and is suitable for assets that lose value at a consistent rate over time, like buildings.

In essence, the diminishing value method front-loads the depreciation, while the prime cost method spreads it out evenly. The choice between the two often depends on the nature of the asset and the financial or tax strategy of the entity owning the asset.

How Does Commercial Depreciation Differ from Depreciation on a Residential Rental Property? 

Commercial and residential rental properties both offer depreciation benefits, but there are distinct differences between the two. Commercial properties are primarily designed for business activities, such as offices, warehouses, or retail spaces. 

These properties often contain various separate depreciating assets, ranging from fixtures and fittings to machinery and equipment. On the other hand, a residential rental property serves as a dwelling, like apartments or houses.

The ATO sets specific depreciation rates for commercial buildings based on their type and age, whereas residential properties typically have a standard depreciation rate for the building’s structure. 

Additionally, in the commercial realm, both property owners and tenants can claim depreciation deductions, with commercial tenants having the added benefit of claiming depreciation for assets they add during their lease, known as fit-outs. In contrast, for residential rental properties, usually only the property owner can claim depreciation. 

Disclaimer:
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.