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IMPORTANT NOTICE - JULY 2004

What do the proposed Depreciation changes mean to you?

By Steve Tucker
Managing Director

What a couple of weeks it has been. Since the discussion paper was released I have been busy in meetings with Investors, Property Professionals and MP's discussing the impact this is going to have.

Put very simply the proposed changes will mean some depreciation rate changes. These rate changes will be in the form of reducing the rate for some items and therefore the depreciation in the short term. Over the long term the depreciation will be very similar. The result will be a reduction in cash flow for investors in the early years of ownership.

I have done some examples as part of a group of Professionals that is working together to inform investors of what is going to happen.

The graphs and table below will help to explain the effects on cash flow and here is an explanation.

BUILDINGS

As an investor currently depreciating your $100,000 building at 4% Diminishing Value (DV) the depreciation is $4,000 in the first year.

The IRD proposes the depreciation rate to be 3%DV or 2% Straight Line (SL).

With the rate at 3% DV the deduction would be $3000 in the first year. Therefore, you would be approx $330 worse off or 6$ per week for cash flow in the first year based on a tax rate of 33%.

If you claimed the proposed 2% Straight line the deduction would be $2000 in the first and every year after. Therefore, you would be approx $660 worse off or $12 per week for cash flow in the first year based on a tax rate of 33%.

CHATTELS AND FIT-OUT

As an investor you can currently claim depreciation separately on fit-out and chattels. These are at various rates but on average work out to approx 10% DV. For Chattels and Fit-out worth $60,000 this would mean $6,000 in depreciation in year one.

We are unsure of what items exactly IRD will classify as building for depreciation but some of the items that we currently claim at increased rates will default back to the building rate as shown above. As we are unsure I have done two calcs. One based on a worst case scenario (larger number of items reduced to the building rate) and a best case scenario (Few items)
Under the best case scenario it is estimated that the average depreciation rate would drop from the current 10% to 7%. This would reduce your first year cash flow by approx $600 or $12 per week.

The worst case scenario would reduce the average depreciation rate back to approx 5% which would mean a reduction in cash flow of $1000 or $19 per week. A big drop.

SUMMARY

These cash flows are only for the first year and the table and graphs show the effects over a longer period. The key for an investor is to have cash flow in the early years of ownership when expenses such as interest are high.

When you combine the reduced cash flow from the Building as well as the Fitout and Chattels the cashflow loss for you as an investor with $100,000 of Buildings and $60,000 of Fitout and Chattels would be $900 - $1,650 in the first year or $17 - $32 per week!

This would hurt you as an investor.

Best Case scenario cash flow change per year including Buildings, Chattels and Fit-out

Worst Case scenario cash flow change per year including Buildings, Chattels and Fit-out

Where to from here?

As investors it is a great idea to make a submission commenting on the discussion paper. For this I will be in contact again in the near future giving you a little more of a brief along with the details and address for submissions to be made.

The more we speak out the greater the chance of reducing the losses to cashflow.