If you own residential investment property, you could claim depreciation on your investment property against your assessable income and save money at tax time. This is one of the significant perks of owning an investment property.
In fact, after interest, depreciation is the second largest deduction available from the list of tax deductions for property investors. Therefore, claiming rental property depreciation every financial year can significantly enhance your cash flow.
In other words, a depreciation schedule may be your new best friend when filing your tax return.
This simple guide will help you understand investment property depreciation. It'll also help determine how you could claim deductions on your tax returns.
What is Investment Property Depreciation?
From a tax perspective, when you purchase an investment property, you are generally treated as having purchased a building plus various separate depreciating assets, also called plant items.
Property depreciation is a tax deduction from the following:
- Capital Works Expenditure (Division 43) on the Property: This may include the buildings or extensions, alterations or enhancements to the building.
- The Decline in the Value of the Property’s Contents: This comprises the plant and equipment assets (Division 40). These include the things not fixed to the property, such as furniture, oven, washing machine, carpets, blinds and other freestanding items.
For every financial year, the Australian Taxation Office (ATO) allows you to claim the loss of value as a tax deduction against your taxable income. This helps you pay fewer taxes.
Moreover, since it's a 'non-cash deduction,' the deductions are built into your property purchase price. This means you don’t have to pay for it on an ongoing basis.
What is a Tax Depreciation Schedule?
All depreciating assets decrease in value over the years due to limited life expectancy. Therefore you must get a depreciation schedule before determining how much you can claim.
A tax depreciation schedule is a comprehensive report outlining all the claimable depreciation deductions for a residential investment property. Property investors have to separate depreciating assets from capital works since they have different depreciation rates.
For tax purposes, you typically need only one tax depreciation schedule per investment property. However, you may need to revise or update your schedule if you implement significant changes to your property.
Typically a property depreciation schedule is prepared by a specialist, or an accredited professional, like a Quantity Surveyor. They specialise in accurately measuring construction costs to maximise your position on your property assets.
Here are some essential pointers to consider when hiring a Quantity Surveyor:
- Accreditation: When seeking suitable Quantity Surveyors, enquire if they are a member of the Australian Institute of Quantity Surveyors (AIQS). An affirmative response will confirm that your Quantity Surveyor has an accredited qualification.
- Costs: To give you an idea, the cost of preparing your property tax depreciation schedule will depend on your residential property, location, and size. But on average, they range between $350 to $750 plus GST. Even better, you are able to claim 100% tax deductions on quantity surveyor fees.
- Timeframe: The process usually takes around 2-3 weeks to complete if you allow the quantity surveyor to inspect your income-producing property as soon as possible. It can take as little as 3 days if your surveyor has quick access to your residential rental property details. Your property manager can liaise with the surveyor for convenient access to your property.
After completing your property depreciation report, your accountant will organise your tax return.
Why You Should Care About Property Depreciation?
When you purchase residential investment properties, your personal objectives would certainly include generating income through rental income and capital gains. Therefore, these investment properties are usually classed as taxable assets.
When you are able to claim tax deductions based on depreciation over the asset's effective life, you may be able to offset your taxable income from your property. This could reduce your tax bill.
How Does Depreciation on an Investment Property Work?
Depreciation on your investment property can be claimed in two areas:
Capital Works
Capital works typically include all expenses related to building the property and implementing structural improvements, extensions and alterations.
If a property was built after 15 September 1987, owners of investment properties could claim deductions at a rate of 2.5% per year, spread over 40 years. This is based on ATO estimates of the typical life span of a building before it needs replacing.
For instance, if it costs you $400,000 to build your new property, you could make a tax claim of $10,000 each year for 40 years (i.e. 2.5% per year).
Depreciating Assets
Depreciating assets are those that do not form part of your rental premises. They are identifiable, have a limited effective life and are not part of the building structure. In addition, it's to be expected that these assets decline in their value over time with use.
For property investors, timber flooring, light fittings, home appliances, carpets and even the rubbish bin are examples of depreciating assets.
The ATO lists the effective life of a depreciating asset and its expected lifespan - that is, how long an investment will usually last before needing replacement.
How Does Depreciation Differ Between Properties?
In general, entitlement to depreciation on rental properties depends on when you acquired the property.
1. Depreciation on Old Properties
Per the Australian tax office, you can only claim capital works deductions on rental residential properties that have been built after 17 July 1985.
From 18 July 1985 to 15 September 1987: The applicable years and deduction rate per year is 4%.
From 16 September 1987 Onwards: You’ll be able to claim 2.5% depreciation. However, for construction related to specific contracts pre-16 September 1987, the rate is 4%.
For properties where construction commenced after 30 June 1997, the capital works should be used deductively in the income year in which the deduction has been claimed.
In addition, you can claim a tax break on depreciating assets, regardless of how old the property is. However, legislation passed in November 2017 introduced significant changes to claims on residential plant and equipment depreciation. As a result, your entitlement to depreciation will depend on when you purchased the property.
Properties Purchased Before 9 May 2017: On plant and equipment that are part of the property - you can claim depreciation based on your surveyor’s assessment of the remaining life and value of that particular asset. This also applies to contracts signed before that date.
2. Depreciation On New Investment Property
For a brand-new property, you may be able to claim deductions on capital works and depreciating assets.
For Property Built after 15 September 1987: You’ll be able to claim 2.5% depreciation each year until it is 40 years old.
Also, if you purchased your property after May 9 2017, depreciation is only applicable for costs on plant and equipment you paid for, such as oven, new carpets and other home equipment. You can also claim tax depreciation on plant and equipment included in your new property purchase. Important considerations include:
For Assets Costing $300 or Less: You can claim an immediate deduction for this cost in the income year in which you used the asset for a taxable purpose.
However, you cannot claim an immediate deduction if that asset belongs to a set of assets that collectively cost more than $300.
For Assets Costing More Than $300: For depreciating assets costing more than $300, you can claim deductions for their decrease in value over their effective useful lifespan.
Subsequent property owners will not be able to claim deductions for depreciation assets purchased property’s previous owner.
However, you should note that Joust does not offer tax advice. While you look for ways to reduce your taxable income, it's always advisable to seek tax advice from a qualified professional and - where applicable - a registered professional adviser.
How to Calculate Investment Property Depreciation?
There are two ways you can calculate depreciation on your income-producing property:
Prime Cost Method
In this method of calculating the depreciation of an asset, you assume uniform depreciation of the asset over its effective life. Therefore, you can claim a fixed percentage of the asset's cost or value throughout its useful life. Thus, in this method, your claim amount will be the same each year for the item's life.
Diminishing Value Method
In this method, your claim will decrease by a particular percentage each year. Therefore, you'll be able to claim more in the first year, and it will become less in the advancing years. This happens mainly because new items depreciate quickly, and the depreciation rate is slower as they age.
How to Claim Depreciation on Investment Property?
Take the example of Margaret who added a fence for her income-producing property on 1 July 2021 for $2,000. It has a useful life of 8 years.
Here's a step-by-step rundown of how Margaret can use the prime cost or diminishing value methods for claiming depreciation.
Prime Cost
The formula to calculate depreciation using Prime Cost is:
- Asset Cost × (No. of Days Held ÷ 365) × (100% ÷ Effective Life of the Asset)
Now applying the Prime Cost Method in Margaret's scenario, we calculate the decline in annual value: $2,000 × (365 ÷ 365) × (100% ÷ 8) =$ 250.
The original cost of the fence ($2,000) minus its decline in value up to 30 June 2022 ($250) is $1,750. Thus, the adjustable value of the fence on 30 June 2022 is $1,750.
Therefore, Margaret can claim a deduction for a decline in value of $250 after one year. Using the Prime Cost Method, she will be able to claim a deduction for a decline in value of $250 for each subsequent year.
Diminishing Value Method
The formula to calculate depreciation using the Diminishing Value Method is:
- Base Value of the Asset × (No. of Days Held ÷ 365) × (200% ÷ Effective Life of the Asset).
Now applying the Diminishing Value in Margaret's scenario, we calculate the decline in annual value: $2,000 × (365 ÷ 365) × (200% ÷ 8) =$ 500.
The original cost of the fence ($2,000) minus its decline in value up to 30 June 2022 ($500) is $1,500. Thus, the adjustable value of the fence on 30 June 2022 is $1,500.
Margaret can claim a deduction for a decline in value of $500 after one year.
In subsequent years, the base value will change based on the reductions in value. The base value for the second year will be $1500 and the calculation will be as follows: $1,500 x (365 ÷ 365) x (200% ÷ 8) = $ 375.
Margaret can claim a deduction for a decline in value of $375 after the second year. Using the Diminishing Value Method, this deduction will continue to decrease over the lifespan of the product.
How Joust Assists Property Investors
Claiming depreciation on an investment residential property can save you money on your tax bill. Moreover, freeing up cash flow in the short term may help you to improve your long-term financial situation.
Joust can help you access home loans to purchase a residential property to invest in. Our Instant Match technology will compare and find the best home loan matching your personal circumstances. You can instantly connect with up to 3 of the most suitable lenders to get started on your home loan journey.
FAQs
Is Depreciation Tax Deductible?
Yes. The Australian Taxation Office (ATO) permits owners of residential rental premises to claim depreciation as a tax deduction under two categories – capital allowances and plant and equipment assets.
What is the Depreciation Rate for an Investment Property?
You can claim capital works deductions if your residential rental property was built after 17 July 1985. The deduction rate is generally 2.5% per year, spread over 40 years ( or 4% per year for 25 years).
Do You Need a Depreciation Schedule for a Rental Property?
Yes, you will need a tax depreciation schedule to claim depreciation on an investment property. However, you can easily access an online depreciation calculator to get a depreciation estimate.
Does Depreciation Affect Capital Gains Tax?
According to ATO, a depreciating asset used exclusively for business or other taxable purposes is not subject to Capital Gains Tax.
Can You Depreciate Your Investment Property Faster?
Yes, the diminishing value increases the depreciation rate earlier and is the preferred method for most investors. However, your accountant can advise which method best suits your personal objectives.
Can Previous Renovations be Depreciated and Claimed?
Yes. Anything in the property that is part of a previous renovation will be estimated by quantity surveyors and depreciated accordingly, even if a previous owner completed the work. This includes depreciation on the new plant and equipment assets and capital works deductions. However, the renovations must be substantial, not merely cosmetic.
Note: The information in this article is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.
