For property investors, depreciation is one of the most effective yet often overlooked strategies for reducing taxable income and boosting cash flow.
By understanding how it works and leveraging it properly, investors can unlock significant financial benefits.
This article delves into the mechanics of property depreciation, explores its tax advantages, and provides practical tips for maximising its potential in your property investment journey.
Understanding property depreciation:
Depreciation refers to the gradual decline in value of a tangible asset over time due to wear and tear. In the context of property investment, this means you can claim deductions on eligible building structures and fittings.
Although depreciation is a non-cash expense, it offers a powerful way to lower taxable income, making it an essential part of an investor’s tax strategy.
While land itself is not depreciable, the structural components of a building and its fixtures can be. Understanding the types of depreciation and what qualifies for deductions is key to maximising your returns.
How depreciation works in property investing:
Depreciation in property investment is typically divided into two categories:
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Capital works depreciation (Division 43) This relates to the structural and fixed elements of a property, such as walls,
floors, roofs, and driveways. Capital works depreciation applies to residential properties constructed after 18 July 1985 and allows
deductions at a rate of 2.5% annually over 40 years.
- Plant and equipment depreciation (Division 40) This covers removable and mechanical assets like carpets, blinds, and appliances. These items can be depreciated over their effective life as determined by the Australian Taxation Office (ATO).
Impact of 2017 legislative changes:
In 2017, the Treasury Laws Amendment (Housing Tax Integrity) Act introduced significant changes for investors claiming depreciation on plant and equipment. Under the new rules:
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Investors can no longer claim depreciation on second-hand plant and equipment assets in properties purchased after 9 May 2017. However,
depreciation on new assets purchased and installed by the investor remains claimable.
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Second-hand assets, while not depreciable, can still contribute to the cost base of the property, reducing potential capital gains tax (CGT)
liabilities upon sale.
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Capital works depreciation (Division 43) remains unaffected, providing deductions for structural components irrespective of when the
property was purchased.
The role of having a Depreciation Schedule in place:
A depreciation schedule is a vital tool for any property investor. Prepared by a qualified quantity surveyor, this document outlines the annual deductions available over the effective life of the property—usually up to 40 years. Without a comprehensive schedule, you risk missing out on significant deductions that could enhance your investment’s profitability.
Tax benefits of depreciation:
Depreciation provides substantial financial advantages, including:
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Reducing taxable income: By claiming depreciation, you lower your taxable income, which reduces your annual tax
liability.
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Enhancing cash flow: The tax savings generated by depreciation can be reinvested into other properties, used to pay down
debt, or allocated to other financial goals.
Example:
- Annual Rental Income: $30,000
- Depreciation Deductions: $8,000
- Taxable Income: Reduced to $22,000, resulting in lower tax liabilities.
Case study:
Lorraine and Samuel own 3 investment properties and below is how depreciation is assessed against all 3 scenarios:
- Newly built residential property
- Year built: 2022
- Construction cost: $400,000
- Deductions: $9,000/year for capital works and $5,000/year for plant and equipment.
- Outcome: $14,000 in annual deductions leads to significant tax savings and better cash flow.
- Established property purchased post-2008
- Purchase price: $550,000
- Capital works deduction: $5,500/year based on construction cost.
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Outcome: While plant and equipment deductions are unavailable under the 2017 rules, structural deductions still offer
notable tax benefits.
- 1980s property with renovations
- Year built: 1982, with renovations in 2017 costing $100,000.
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Deductions: $0/year for original structure as is fully depreciated, $2,500/year for renovations, and $3,000/year for new
assets installed.
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Outcome: Total deductions of $5,500/year highlight the value of including renovations in depreciation claims.
What you can claim:
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Capital works (Division 43): Includes structural components like walls, roofs, and renovations. Eligible for all properties
built after 18 July 1985.
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Plant and equipment (Division 40): Covers assets such as dishwashers, curtains, and air conditioning units. Only new assets
purchased by the investor are claimable under current legislation.
Tips for maximising depreciation:
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Engage a qualified quantity surveyor: Their expertise ensures accurate schedules and maximised deductions.
- Keep detailed records: Maintain thorough documentation of renovations and asset purchases.
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Pro-rata deductions: Claim depreciation for properties purchased mid-year by calculating partial-year deductions.
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Seek professional advice: Tax experts can align depreciation strategies with your broader investment goals.
Dispelling common myths:
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“Only new properties qualify for depreciation.” Many older properties can benefit, especially if they have
undergone renovations.
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“Depreciation claims increase audit risk.” Accurate, well-documented claims are fully compliant with ATO
regulations and do not elevate audit risks.
Depreciation is a critical tool for property investors aiming to reduce taxes and boost financial returns. With a thorough understanding of depreciation laws and the help of experienced professionals, you can unlock substantial benefits and enhance your investment’s profitability.
How we can assist you:
At Ramsey Property Wealth, we specialise in helping astute, time-poor property investors navigate the complexities of investing, including depreciation. Partnering with trusted quantity surveyors and tax professionals, we ensure your claims are optimised for maximum benefit.
Whether you’re an experienced investor or just starting out, we’re here to support you at every stage.
Contact us on 1300 001 215 to learn how we can help you achieve your property wealth goals.
