Property depreciation is one of the most valuable yet under-utilised tools in an investor’s arsenal. It’s a way to reduce taxable income by accounting for the natural wear and tear of your property over time. Understanding how depreciation works and how to claim it can enhance your cash flow, improve your tax outcomes, and maximise the returns on your investment property.

This guide unpacks everything you need to know about property depreciation, from the basics to strategies for maximising your deductions.

What Is Property Depreciation?

Property depreciation is a tax deduction that allows investors to offset the loss of value in their rental properties. Over time, assets such as buildings, appliances, and fixtures deteriorate due to usage and aging. By claiming depreciation, you reduce your taxable income, effectively lowering your tax bill.

The Australian Taxation Office (ATO) recognises two types of property depreciation:

• Capital Works Depreciation (Division 43): Covers the structural elements of a property, such as walls, roofs, and fixed infrastructure.
• Plant and Equipment Depreciation (Division 40): Relates to removable items like carpets, air conditioning units, and appliances.

Claiming these deductions helps property owners manage the financial impact of wear and tear without bearing the full cost on their own.

How Does Property Depreciation Work?

To claim property depreciation, you must first understand the two primary categories:

Capital Works Depreciation

Capital works deductions apply to the structural aspects of a property, such as:

• Building framework
• Roofs and walls
• Driveways and fences

For properties built after September 15, 1987, you can claim up to 2.5% of the construction cost annually for 40 years. Renovations or improvements completed after this date may also be eligible, provided you have accurate records.

Plant and Equipment Depreciation

Plant and equipment refer to easily removable assets within the property, such as:

• Kitchen appliances
• Furniture and fixtures
• Blinds and carpets

Depreciation rates for these items vary based on their "effective life," as determined by the ATO. For instance, carpets may depreciate faster than refrigerators, allowing for larger deductions in the earlier years of ownership.

Why Do Investors Need a Depreciation Schedule?

A depreciation schedule is a detailed report that outlines all the deductions available for your investment property over its lifetime. It’s prepared by a qualified quantity surveyor who inspects your property and identifies eligible assets.

Key reasons to get a depreciation schedule include:

1. Compliance: Ensures your claims align with ATO regulations.
2. Accuracy: Identifies all eligible deductions, avoiding missed opportunities.
3. Efficiency: Saves you and your accountant time during tax season.

The cost of a depreciation schedule is also tax-deductible, making it a worthwhile investment for property owners.

New vs. Established Properties: Depreciation Differences

Your property’s age significantly impacts your depreciation deductions. Here's how new and established properties differ:

New Properties

Newly built properties often provide higher depreciation benefits because:

• Construction costs are recent, leading to larger capital works deductions.
• Brand-new assets, like appliances, can be fully depreciated without restrictions.

Developers of new properties often include detailed cost breakdowns, simplifying the preparation of depreciation schedules.

Established Properties

For properties purchased after May 9, 2017, the rules have tightened. Owners of established properties can no longer claim depreciation on second-hand plant and equipment. However, you may still claim:

• Capital works deductions for buildings constructed after 1987.
• Depreciation on newly purchased assets like appliances or furniture, as long as they were added after the property was acquired as an investment.

While established properties may offer fewer depreciation benefits, strategic renovations can create opportunities for new claims. You can review the ATO’s rules on depreciable assets and their lives here.

Methods for Calculating Depreciation

The ATO allows two methods for calculating depreciation:

Prime Cost Method

Also known as the straight-line method, this approach depreciates assets evenly over their effective life. It offers consistent deductions each year, making it ideal for investors seeking predictable tax benefits.

Diminishing Value Method

This method applies a higher depreciation rate in the early years of ownership, with deductions decreasing over time. It’s advantageous for investors prioritising short-term cash flow improvements. Selecting the right method depends on your investment strategy. A professional quantity surveyor can help identify the best approach for your property.

Benefits of Claiming Property Depreciation

Investors who effectively leverage depreciation can enjoy a range of financial benefits:

• Reduce Taxable Income: Depreciation lowers your taxable income, reducing the amount of tax owed.
• Boost Cash Flow: Savings on taxes provide additional funds for reinvestment or other expenses.
• Non-Cash Deductions: Unlike repairs, depreciation doesn’t require out-of-pocket spending but still offers significant tax advantages.
• Offset Wear and Tear: Compensates for the inevitable decline in property value over time.

By incorporating depreciation into your tax strategy, you can significantly enhance your property’s profitability.

Common Depreciation Mistakes to Avoid

Navigating property depreciation can be complex, and even seasoned investors can make mistakes. Common pitfalls include:

• Failing to Obtain a Depreciation Schedule: Without a professional report, you risk under-claiming or missing deductions.
• Overlooking Renovations: Many investors forget to claim deductions for renovations or improvements.
• Claiming Ineligible Assets: Items like second-hand appliances purchased with the property may not qualify under current rules.
• Inadequate Record Keeping: Accurate documentation of costs and dates is essential for compliance.
• Misunderstanding Methods: Using the wrong depreciation method can impact your deductions and cash flow.

Working with a qualified quantity surveyor and a knowledgeable accountant can help you avoid these errors.

Tips for Maximising Depreciation Deductions

To get the most out of property depreciation, consider these strategies:

1. Invest in New Properties: New builds often offer the highest deductions across both capital works and plant and equipment.
2. Renovate Strategically: Renovations can increase the claimable value of your property, provided you keep detailed records.
3. Engage a Professional: A quantity surveyor ensures no eligible deductions are missed.
4. Review Regularly: Update your depreciation schedule when new assets are added or renovations are completed.
5. Choose the Right Method: Tailor the depreciation method to your cash flow and tax strategy.

Conclusion

Property depreciation is a powerful tool that can transform the financial performance of your investment. By understanding the types of depreciation, leveraging professional schedules, and avoiding common mistakes, you can reduce your taxable income, enhance cash flow, and maximise the long-term profitability of your property portfolio.

If you’re considering an investment property and want to work with an experienced investment team of buyer’s agents, reach out to us at Ally Property Group.

 

 

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General Information Warning: The information contained herein is of a general nature only and does not constitute in any way, personal advice. You should not act on any recommendation without considering your personal needs, circumstances, and objectives. We recommend you obtain professional property investment advice specific to your circumstances.