by Nicola Woodward

FAVOURITES – 21 April 2009 – Accelerated Depreciation is a core platform of the property industry as a way to green buildings – but there are major flaws in this approach and better ways to achieve the desired outcomes….

“Green depreciation” is a term that has recently been coined for providing accelerated tax depreciation for property related capital expenditure that provides a green payback.

Tax depreciation is a tax deferral mechanism that already provides capital allowance deductions for refurbishment works as well as write offs for any plant or building items that are demolished or disposed of as part of the project.

The rationale for the introduction of green depreciation has been this: there is an environmental need for existing buildings to be brought into the “green” fold but there is a cost premium in refurbishing an existing building to green standards over traditional design.

There is an existing framework for providing tax deferrals for capital expenditure in the form of tax depreciation, so by accelerating those deferrals for green refurbishments existing building owners will be encouraged to spend that extra capital whilst at the same time being revenue neutral to treasury.

Not so fast

There are a few flaws in this logic.

Firstly, there is the problem of definition. What is green and how is it measured? What are the real differences between the environmental impact of refurbishing a 2.5 star NABERS rated existing building using traditional building materials and demolishing that building and replacing it with a 6 star Green Star building?

The current rating systems available in the Australian market do not allow such a comparison to be made. Green Star is a tool that looks at the design aspects of building whereas NABERS measure actual operating data and scores a building on 12 month periods of use.

Immediately, green depreciation hits another hurdle – if you use NABERS as a benchmark of green how do you match the timing of finishing a project and getting a rating done based on occupation and usage when tax depreciation would be available upon practical completion?

Alternatively, if you use Green Star as a benchmark you could be left with a fantastically designed building that has not been commissioned well and operates well below its capabilities.

Next, let’s tackle cost.

It has long been held that transforming an existing building into a sustainable building incurs a premium cost. In the current economic climate building owners cannot afford to fund their current capital expenditure commitments let alone the extra costs relating to greening.

This is one of the key problems with the green depreciation argument. The acceleration of tax depreciation is merely a cash flow benefit in the period immediately following capital expenditure; it is not a long term solution to cost.

The whole point of sustainable development is that the whole life cost of a building is taken into account. When looking at whole of life costs, real benefits will be made in any ongoing reductions in vacancy periods, energy costs and repairs and maintenance or increases in the effective life of assets.

Accelerated depreciation not so effective in the long run

Accelerating the tax depreciation available will make almost no difference to the whole life cost of the expenditure. That is not to say that the accelerated depreciation will not make a difference at all, but it will be based on the time value of money and is more likely to be seen as the icing on the cake rather than the impetus to spend.

But it can help with marginal projects

I suggest that if building owners currently make green decisions based on cost, changing the timing on tax deductions will not make green expenditure more likely, although it may make some marginal projects viable where cash flow issues are the stumbling block.

I have yet to see any evidence that the new Investment Allowance which is a one off bonus tax deduction and not just a timing change has led to any meaningful new capital expenditure.

Those who do take advantage of the tax break will have been going to spend the money anyway and may alter the pattern of their expenditure but it is unlikely to make them spend more over the period of a year.

Another shortcoming of green depreciation, as it currently is being tabled, is the emphasis on spending capital rather than being smart with what you do with your existing building.

Where’s the benefit for good management and education?

For example, there is no benefit suggested for those who achieve a green building by good management and educating the tenants.

The fundamental question that needs asking is this; will building owners take into account the tax depreciation when planning their refurbishments?

My experience over the last 15 years of working in this area is that the answer will be no in the vast majority of cases.

It is still not usual practice to consider in detail the tax depreciation available when acquiring a building. Estimates of tax depreciation available are sometimes put into models but hurdle rates and valuations rarely take into account after-tax returns. When refurbishments are undertaken, available write offs are often overlooked and it is rare for the after tax position to be considered.

Again we come back to the fact that tax depreciation is a deferral of tax. When a building is sold the depreciation already claimed is clawed back by way of capital gains tax (buildings) or as a balancing adjustment (plant/depreciating assets).

And what if the owner plans to sell?

Therefore the building owner gains a timing difference on the tax. If the owner plans on improving the building and then to sell it on, green depreciation will not benefit them.

In the US tax credits work better

Other incentives that have been adopted around the world should be examined as there are simpler and more effective mechanism for encouraging green refurbishments and to date there has been little debate on this.

Tax incentives as a tool for improving the green profile of buildings can be found in many jurisdictions. For example, in Oregon USA there are tax credits available for LEED platinum rated developments that can be used by the building owner or passed on to a project partner. This is particularly useful where you have a non-taxpaying building owner who would otherwise not be able to take advantage of the incentives.

Federal, state and local governments have had great success with devising and implementing green building funding projects around Australia. The Green Building Fund announced in May 2008 is a good example of this. It provides up to 50 per cent of the cost of a green building project up to $500,000.

Melbourne City Council has an aim to have 1200 retrofitted commercial buildings in Melbourne by 2020 to achieve its zero net emissions by 2020 goal. This project takes a holistic view of the process and addresses the capacity of the property industry to undertake these projects as well as facilitating access to funds.

I would argue that this structured and targeted approach will provide more lasting green benefits to the building stock.

And where is the debate, anyway?

Green depreciation as a concept is not without merit. What is of concern is that there has to date been no debate around what alternatives are out there or how it fits in with where we want to go as a country to improve the performance of our commercial building stock.

If those issues can be resolved and green depreciation is deemed to be the way forward, then the problems with definition and equity as well as the practicalities of implementing such a complex overlay of the existing tax depreciation regime can be addressed.

Nicola Woodward is director, Apex Property Consulting Pty Ltd

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