Why calculate depreciation on an investment property?

By calculating depreciation on your investment property, you may be able to claim an income tax deduction and lower your overall tax payment in a financial year.

When buying an investment property, you need to consider that your costs will go far beyond the initial purchase price. You will also incur costs preparing the property for rental, and maintaining it in good-working order for your tenants.

There may be initial costs fitting the property out, renovating or repairing it. Furthermore, over time wear and tear may mean the replacement of:

  • flooring,
  • furniture,
  • appliances.

Furthermore, structural improvements may need to be made.

This creates an expense to you so will lower your net income. However, by calculating depreciation – the decline in value of an asset over time – you may be able to claim your costs as an income tax deduction.

Therefore it’s important to keep detailed records of all the expenses you incur in holding a property so you can offset your tax liability.

We always recommend that you speak to a tax accountant or contact the Australian Taxation Office (ATO) for advice on depreciation, but here is some general information:

What is building depreciation?

Building depreciation takes in more than just the structure itself. It also allows you to claim for depreciation of plant and equipment, which are the fixtures and fittings. This means you can claim a percentage of the money you spend on the building and its fixtures.

Typically, this rate stands at 2.5%, which applies from the date of the property’s construction. Say you buy an investment property today for $500,000 that cost $200,000 to build back in 2000. Using depreciation of 2.5% against its original construction cost, you could claim up to $5,000 annually against the income you receive from rent.

However you can only do this until 2040 as 40 years is the maximum time the ATO says a building can depreciate before it reaches its life expectancy.

What about furniture depreciation?

The ATO allows you to claim against the cost of your furnishings for several years after you fit them. On top of that, you can claim further deductions for any furniture you fit in the property after the purchase date.

What is a depreciation schedule?

A depreciating asset will decline in value over the years as it has a limited life expectancy. A depreciation schedule allows you to figure out which items you can claim on, and how much value each will lose over time.

Your schedule should include deductions for:

  • plant,
  • equipment, and
  • construction costs.

Some people create their investment property depreciation schedule, but it often pays to employ the services of a quantity surveyor to ensure it’s correct and that you don’t miss anything.

If you do use a professional, expect to pay somewhere in the region of $400 to $750. However, you may find you can get the depreciation schedule free of charge from a developer if you’re buying a newly built property.

Prime cost vs. Diminishing value

How tocalculate depreciation?

There are two ways of calculating depreciation, as detailed by the ATO:

  • Prime Cost Depreciation (Straight line) – this assumes that the value of a depreciating asset decreases uniformly over its effective life.
  • Diminishing Value – this assumes that the value of a depreciating asset decreases more in the early years of its effective life.

Using the ATO depreciation calculator

The ATO has a calculator which you can use. Note this is general in nature and not specifically for individuals investing in property. A good tip: if you create myGov account and link it to ATO, you can save your records and calculations for use in your tax return.

Find out more with the ATO depreciation calculator and see some working examples by visiting the ATO website.

Do depreciation claims impact CGT?

Depreciation can help you save a lot of money on your tax bill in a financial year. However, you cannot claim this tax allowance more than once.

Therefore, if you decide to sell your investment property you will have to deduct the depreciation you have already claimed from your cost base. Reducing your cost base will increase your gross capital gain and therefore the tax you will pay.

Despite this tax liability, freeing up cash flow in the short term could also make good financial sense over the long term. For example it may enable you to pay down your debt faster, or make additional investments to generate new income streams.

So it’s always worthwhile speaking to a professional to discuss your financial objectives and to decide which strategy will be most beneficial to your personal circumstances.

Next steps:

With Alexi Neocleous

The information in this article is general in nature. Please seek advice from a licensed professional when making financial decisions.

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