Chattels Depreciation The Basics

Posted on Tuesday, February 25 2014

As you have an interest in property investment you may have heard the term “Chattels Valuation”. This article will cover the basics of depreciation and future articles will cover the changes that have taken place in recent times.

Before we begin lets clarify the term “Chattels Valuation”. I prefer to refer to it as a “Depreciation Apportionment” as what we are actually required to do by IRD is apportion the purchase price of your property into the various components and depreciation categories, this includes the land and buildings not just the chattels.

There are 3 main advantages that are marketed.

1. Maximise Depreciation
2. Minimise Depreciation Recovery
3. Reduce risk of IRD penalties

Let me explain what these mean to you.

First of all you need to understand what depreciation is. The technical term is “An allowance for wear and tear on an asset over its useful life” IRD is aware of this and therefore allow you to claim a $ amount of depreciation each year as an expense in your accounts. Just as paying the rates is an expense, so is depreciation. The difference is that paying the rates means you open your wallet. Depreciation is a non-cash expense it just happens year after year, no need to open your wallet. Claiming something as an expense in your accounts means that you do not pay tax on that expense.

Let’s have a look at an example

Rental income $250 per week $13,000 per year
LESS Cash Expenses (Insurance, rates, interest etc) -$10,000 per year
Income for the year (physical income in your pocket) $3,000 per year
Now lets also take into account the depreciation
LESS Non-cash Expense (Depreciation) -$8,000 first year
TAXABLE income for the year (What IRD taxes you on) -$5,000 Tax loss

This example means that you get $3,000 in your pocket for the year, or $57 per week (positive cash flow). However, when it comes to paying tax IRD calculates it on the amount after taking into account depreciation. You still get to keep the $3,000 but you have made a $5,000 loss for tax (negatively geared for tax). Now depending on your ownership structure and proposed changes the current government is looking at, you may be able to apply this tax loss to your personal income. (Remember it is a non-cash loss, it hasn’t actually cost you anything) Your salary of $45,000 may now be taxed based on a salary of $40,000.

The aim now is to MAXIMISE DEPRECIATION. The more depreciation you claim the less tax you pay and obviously the more cash you have in your pocket. As mentioned earlier IRD accepts that assets wear out over time and therefore reduce in value. Every asset lasts for a different period, hence why all assets have varying depreciation rates. Take the house structure for instance, IRD gives it a useful life of 80 years whereas carpets have a useful life of 5 years. The house lasts longer than the carpets and therefore carpets have a much higher depreciation rate. To maximise your depreciation you need to have the purchase price of the property split into every separate individual asset and then apply the correct depreciation rate. The house structure itself only depreciates at 3% per annum currently and from 1 April 2011 it will be reduced to 0%. All of the other assets generally depreciate at 8% – 66.7%.

When you sell your property for a profit, as we all aim to do, IRD will suggest that because the property has been sold for a profit then there has been no depreciation. The simple fact is that most items wear out with use, hence why you were claiming depreciation. This is where you MINIMISE DEPRECIATION RECOVERY. By having a specialist chattels valuation/depreciation apportionment completed when you purchase the property you will have a detailed list of all the various assets and their individual values. This gives you a point to argue when you sell the property. If you had no idea of the individual values at purchase it would be impossible to argue that they had decreased over time and were now worth less at the date of sale.

You cannot afford to get things wrong when dealing with IRD, the penalty regime is far too harsh. The only way to REDUCE THE RISK OF IRD PENALTIES is to have a chattels valuation/depreciation apportionment completed by a specialist.

How good is depreciation?…Fantastic!

Happy hunting …

 

 

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Expert's Bio

Steve Tucker

Valuit aims to stay the market leader in depreciation apportionments and educate investors and accountants in this specialist area, as many investors are not fully aware of the potential benefits.

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