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The end of a financial year always reminds us of the tax benefits of investment properties.
I’m sure every property investor knows well about negative gearing, and it’s not a secret that you can deduct your holding costs, such as insurance and rental expenses as well as loan interests, from your rental income. However, surprisingly, more than half of property investors forget about one thing when lodging their tax return: property depreciation.
InvestorKit works with DuoTax to prepare Tax Depreciation Schedules for our clients to enjoy yearly depreciation deductions. Today let’s look at property depreciation and the Tax Depreciation Schedule in detail: what they are, the benefits and limits, and how it works.
Property Depreciation
Depreciation is the wear and tear that occurs as things get older. As to properties, both the structure and the inside fixtures’ value decrease as they age.
The Australian Tax Office (ATO) allows property investors to claim the property depreciation as a tax deduction from the rental income.
For a property, there are two main types of depreciation to claim:
a. Capital works deduction (referred to by the ATO as Division 43): The depreciation of the structure of the building, e.g. retaining wall, timber framing, concrete slabs, built-in wardrobes, etc.
b. Plant and equipment deduction (referred to by the ATO as Division 40): The depreciation of fixtures and fittings, which are easily removable, inside the building, e.g. oven, carpets, blinds, smoke alarms, etc.
To claim the above depreciations and know precisely how much you should claim each year, you need a
Tax Depreciation Schedule
The Tax Depreciation Schedule is a report prepared by a qualified quantity surveyor providing a breakdown of the depreciation deductions you can claim for an investment property and eligible assets. It includes the original value, the estimated effective life, and the depreciation rate for the structural components and the plant and equipment assets.
What are the benefits of claiming property depreciation?
Property depreciation provides an obvious tax benefit for investors, as you can offset the cost of the property’s wear and tear against its rental income. To be more specific, the benefits include:
- Improving cash flow – It could be the difference between having a negatively geared property and enjoying a positive cash flow.
- Faster portfolio building journey – With cash flow improved, you’ll be less stressed holding the current property/properties and be able to save faster to buy the next and the next…
- One-off cost – You need to pay the quantity surveyor only once, and you can claim depreciation with the same schedule for the rest of the years.
- Non-cash deduction – Unlike claiming rental expense deductions, where you need to claim what’s spent, claiming depreciation doesn’t require you to spend the amount beforehand.
However, depreciation shouldn’t be your goal.
While investors can benefit from property depreciation, claiming depreciation should never be your goal.
Firstly, it’s the outcome as properties/assets naturally get old, not something you can ‘optimise’; Examples of something you can optimise are rental income growth (which can be optimised by buying in a high-rental-pressure location) and short-term value growth (which can be optimised by investing in a high-demand-low-supply market).
Secondly, the claimed deductions will be (at least partially) returned when the property is sold. When selling a property, your capital gain outcome (the amount on which CGT is charged) is calculated by deducting your cost base from the gross capital gain. And guess what? The depreciation you have claimed in previous years will be excluded from the cost base. In other words, the tax you saved before needs to be paid now. Of course, if you have held a property for more than a year before selling, you will only lose half of your claimed tax benefit due to the 50% CGT discount.
Despite its limits, depreciation is a handy tool to improve your cash flow, especially in a high-interest-rate environment like now.
Then what kind of properties can claim depreciation? And
Can I claim depreciation if my investment property is old?
Many people believe that tax depreciation deductions only apply to new properties. That’s not true. You can undoubtedly claim depreciation on old properties, too.
Let’s look at how each category of depreciation is calculated.
- Capital works deduction – If a property was built after 15 Sep 1987, you could claim 2.5% depreciation each year until it’s 40 years old (40 years = the general effective life of a residential building). If, in this year (2023), you purchased a house built in 2003, it still has 20 years of effective life left to claim depreciation.
- Plant and equipment deduction – Assets have shorter effective life than buildings, and the length varies between assets. For example, carpets’ effective life can be 8 years, while air conditioners’ can be 10 years. You can claim an asset’s depreciation at a rate calculated based on its effective life.
Here is an example.
In 2022, Jane bought an investment house built in 2002, and she did some renovation, including repainting walls, fixing the outdoor patio, installing a new toilet, air conditioners, dishwasher, blinds, carpets, etc.
She ordered a Tax Depreciation Schedule from DuoTax after the renovation. The below table lists what she can claim and at what rates.
The value of this property is approximately $400k, and according to Jane’s Tax Depreciation Schedule, she can claim over $4000 worth of depreciation each year for the first 10 years of holding the property and over $3000/y in the second decade.
In a nutshell, depreciation is the outcome of your property getting worn, which you can claim to save on tax during your holding period. It should never be your goal in property investing, but it is a great tool to improve cash flow. Want to claim depreciation of your property this year? You need a good quantity surveyor to prepare a Tax Depreciation Schedule, and DuoTax is one of the best we know. Many contents in this blog are thanks to them. To learn more about property investment, tax depreciation, and more quantity surveying services, check out their website!
If depreciation isn’t your goal, what should be? It can be long-term equity growth, short-term value surge, portfolio stability, healthy rental growth, etc., depending on your financial plan and needs. InvestorKit is the buyers’ agency that helps you clarify your investment goal(s) and provide the right support to achieve it sooner. Would like to work with us and fast-track your property investment journey? Talk to us today by clicking here and requesting your 45-min FREE no-obligation consultation!