Div 40 Depreciation for SMSF Property
Self-managed super funds (SMSF) are one way Australians can take control of their retirement savings; they can manage their investment assets themselves. So, SMSFs have become a popular way for Australian investors to buy and hold investment property.
At the end of June 2021, the Australian Taxation Office reported that SMSFs accounted for $913.7 billion.
Using your self-managed super fund for property investment is a great way to diversify your portfolio and increase retirement savings.
However, you must also understand the strict compliance rules that come with managing your own super fund.
You should also ensure that you’re maximising the tax benefits of holding your investments within your SMSF. For example, one of the significant tax benefits of owning an investment property within an SMSF is the ability to claim Division 40 depreciation on plant and equipment assets.
This deduction allows SMSF trustees to write off the value of removable assets like appliances, furniture and fittings over their effective life, potentially reducing the fund’s taxable income from the rental property
So, in this blog post, we will provide an overview of the rules you need to familiarise yourself with when it comes to investing with your SMSF and the best way to maximise your tax deductions.
What is Division 40/Capital Works Deduction?
Division 40 of the Income Tax Assessment Act 1997 allows SMSF investors to claim depreciation deductions for the decline in value of qualifying “plant and equipment” assets that are not a structural part of the building itself.
These assets include items like:
- Ovens, dishwashers, and rangehoods
- Air conditioners, heaters, and ceiling fans
- Carpet, floating floors, and window coverings
- Solar panels, hot water systems
- Appliances like washing machines and dryers
Essentially, Division 40 covers any removable assets that can be easily installed, removed or replaced in a property over time as they depreciate.
To claim deductions, the assets must be owned by the SMSF and used to generate rental income from the investment property. The deductions are calculated based on the asset’s cost and its effective life, as set by ATO rulings.
For example, if your SMSF purchased $15,000 worth of new appliances for the rental property, and they have an effective life of 10 years, you could claim $1,500 in depreciation deductions each year until they are fully written off.
Note: Plant and equipment deductions can only be claimed by the current owner of the property. So if your SMSF purchases a second-hand property, you can only claim deductions for new assets, not ones that were previously owned by someone else.
Claiming Div 40 Depreciation for SMSF Properties
To claim Division 40 capital works deductions for your SMSF’s investment property, there are a few key steps to follow:
1. Obtain a Tax Depreciation Schedule
The first step is to engage a qualified quantity surveyor to conduct an on-site inspection and prepare a comprehensive tax depreciation schedule. This report will detail all qualifying plant and equipment assets owned by your SMSF, including:
- Asset descriptions and dates of acquisition
- Effective life determinations per ATO rulings
- Opening and unclaimed value for depreciation purposes
2. Calculate Depreciation Deductions
Using the asset values and effective life details in the schedule, you can calculate the annual Division 40 depreciation deduction for each plant and equipment asset. This is done by writing off the asset’s cost over its effective life on a diminishing value basis using the double declining balance method specified by the ATO.
For example, if your SMSF purchased a $5,000 air conditioning unit with a 10-year effective life, you could claim around $1,000 in year 1, $800 in year 2, and so on until it is fully depreciated.
3. Claim the Deduction
This total Division 40 depreciation amount can then be claimed as a deduction against your SMSFs net rental income in its annual tax return.
Be sure to retain the depreciation schedule and all supporting documentation, like purchase receipts and installation evidence. The ATO may request these records to verify your claims.
Tax Benefits of Depreciation
Maximising your Division 40 depreciation claims can provide substantial tax savings for your SMSF each year by reducing the taxable net rental income from the investment property.
Since SMSFs are only taxed at 15% on rental income and capital gains from assets like property, being able to claim significant depreciation deductions makes a big difference to your after-tax returns.
Let’s look at an example:
Say your SMSF’s residential investment property generates $30,000 in rental income for the year. From the tax depreciation schedule, you calculate that you can claim $8,000 in Division 40 depreciation on the property’s plant and equipment assets.
Without claiming depreciation, your SMSF would pay $4,500 in tax on the full $30,000 rental income (15% of $30,000).
However, by claiming the $8,000 Division 40 deduction, your taxable net rental income is reduced to $22,000 ($30,000 – $8,000). This results in a tax liability of only $3,300 (15% of $22,000).
That’s a tax savings of $1,200 for that year alone from maximising your Division 40 depreciation claims.
Over many years of holding the property, those annual tax savings compound and can amount to tens of thousands of dollars in reduced taxable income for your SMSF.
Other SMSF Investment Property Rules
While maximising Division 40 capital works deductions is important, there are several other key rules SMSF trustees must follow when investing in property through their fund:
Sole Purpose Test
According to the ATO, all investment decisions made by an SMSF must satisfy the sole purpose test of providing retirement benefits to members. This means properties cannot be acquired for any other purpose, like providing current day-to-day living accommodation.
Related Party Rules
SMSFs are prohibited from acquiring assets like property from related parties of the fund, unless it is an investment acquired through an arm’s length transaction. Related parties include members, relatives, associates, and entities the members control or influence.
Borrowing Rules
If borrowing to purchase a property, SMSFs must use a limited recourse borrowing arrangement (LRBA) where the asset is held in a separate trust until the loan is fully repaid. This protects other SMSF assets from being used as collateral.
Residential Property Usage
SMSF members or related parties cannot reside in or use a residential property owned by the fund, even if market rent is paid. The property must only be used for genuine rental purposes.
Ensuring full compliance with these rules, in addition to properly claiming Division 40 deductions, is critical for SMSF trustees. Breaching the regulations can result in significant penalties and taxes from the ATO.
Getting Professional Advice
It can be challenging, even for the most financially savvy investors, to navigate the complex world of SMSF investments and property depreciation. That’s why you should seek guidance from qualified professionals to ensure you maximise your benefits while remaining fully compliant.
When it comes to claiming Division 40 deductions, your first point of contact should be an experienced quantity surveyor. They have the specialised knowledge to conduct detailed property inspections and prepare an ATO-compliant tax depreciation schedule. This report lays the foundation for claiming your maximum legitimate deductions.
However, a quantity surveyor is just one piece of the puzzle.
You’ll also want to work closely with an accountant who has extensive experience with SMSF property investment and tax planning. They can review the depreciation schedule, ensure the deductions are calculated and claimed properly in your fund’s tax returns, and provide advice on other tax implications.
If you’re looking to borrow to purchase a property through your SMSF, it’s wise to consult a financial advisor as well. They can evaluate your investment strategy, cash flow and can recommend appropriate loan structures that comply with the limited recourse borrowing arrangement (LRBA) requirements.
Finally, a lawyer specialising in SMSF legislation and property law can assist with reviewing or establishing the trust deeds and other legal components of your fund’s property investments. This helps mitigate non-compliance risks with sole-purpose tests, related party rules, and other regulations.
Key Takeaways
- Division 40 allows SMSF trustees to claim depreciation deductions for the decline in value of qualifying plant and equipment assets in their residential investment properties.
- Claiming these deductions can significantly reduce your SMSF’s taxable income and improve cash flows from rental properties.
- To maximise claims, obtain a tax depreciation schedule prepared by a qualified quantity surveyor.
- Calculate deductions correctly based on each asset’s cost and ATO-determined effective life using the diminishing value method.
- Ensure full compliance with other SMSF property rules like the sole purpose test, related party transactions, borrowing requirements, etc.
- Seek professional guidance from accountants, financial advisors, lawyers and other experts to optimise your investment strategy.
At Property Tax Specialists, our experienced advisors can provide you with expert SMSF advice, including structuring ownership of property portfolios to meet your goals.
Get in touch today if you want more information about how we can help ensure all your property investments are legally compliant and set up for maximum growth.
FAQs
What Assets are Depreciating in Division 40?
According to the sources provided, Division 40 covers the depreciation of “plant and equipment” assets, which are assets that can be easily removed from a building. These include items like dishwashers, stoves, blinds, carpets, fans, air-conditioners, hot water systems, smoke alarms, and other fixtures and fittings that are not structurally part of the building itself. Essentially, Division 40 allows depreciation deductions for the decline in value of these removable assets over their effective life as determined by the ATO.
Is Carpet Div 40 or 43?
Carpet falls under Division 40 as it is considered a removable “plant and equipment” asset, not a structural component of the building. The sources specifically list carpet as an example of a Division 40 depreciating asset for residential properties. So any carpet installed in an investment property can be depreciated under Division 40 over its effective life set by the ATO.
Is Depreciation able to be Claimed Under Division 40 of the Income Tax Assessment Act 1997?
Yes, depreciation deductions for the decline in value of eligible “depreciating assets” are allowed to be claimed under Division 40 of the Income Tax Assessment Act 1997. The key operative provision is Section 40-25(1), which states:
“You can claim an amount equal to the decline in value for an income year of a depreciating asset that you held for any time during the year.”
So, Division 40 provides the legislative basis for claiming these depreciation deductions on qualifying plant and equipment assets used for producing assessable income.
DISCLAIMER: This information has been prepared without taking into account your objectives, financial situation or needs. Because of this, you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.
Amir Ishak is a Limited Authorised Representative 1269908 of Merit Wealth Pty Ltd, Australian Financial Services Licence 409361, ABN 89 125 557 002
