What is Property Tax Depreciation?
Depreciation refers to the wear and tear that occurs as items age, leading to a decrease in their value. For investment properties, depreciation applies to both Plant and Equipment and Capital Works, which are classified differently for tax purposes, and it is essential to calculate depreciation accurately to maximise tax benefits.
As an investor, you can claim tax deductions for this depreciation, potentially increasing your tax refunds.
The Australian Taxation Office (ATO) prescribes two methods for calculating property depreciation: the prime cost method and the diminishing value method. These methods determine how much you can claim over time.
A tax depreciation schedule, an ATO-compliant document, helps investors maximise these deductions by breaking them into two parts: Capital Works (Division 43) and Plant & Equipment (Division 40).
Understanding Property Tax Depreciation
Property tax depreciation is a valuable tax deduction that allows property investors to claim the decline in value of their investment property’s assets over time. This encompasses not only the building itself but also fixtures and fittings such as furniture, appliances, and other equipment.
The Australian Taxation Office (ATO) permits property investors to claim depreciation on their investment properties, which can significantly reduce their taxable income and, consequently, their tax bill.
By understanding and leveraging property tax depreciation, property investors can enhance their financial returns and optimise their investment strategies.
Importance of Depreciation
Depreciation is a critical concept for property investors, as it significantly reduces taxable income and lowers tax bills. By claiming depreciation on their investment properties, investors can offset the natural wear and tear on their assets, thereby reducing their tax liability.
Additionally, depreciation helps investors manage their cash flow more effectively and make informed decisions about their investment properties. Understanding and leveraging depreciation can lead to better financial outcomes and a more robust investment strategy for property investors.
Capital Works (Division 43)
Capital Works deductions apply to the structural elements of a building and items fixed to it. Examples include:
Residential
Commercial
These deductions are often referred to as capital allowance and play a crucial role in tax return evaluations for property investors.
Does My Investment Property Qualify for Capital Works Deductions?
Eligibility depends on:
- The construction date of your building.
- The type of building you own or lease.
Additionally, the construction cost of your building, accurately determined by a qualified quantity surveyor, significantly impacts the amount of depreciation you can claim.
Note that from January 1, 2025, build-to-rent developments are eligible for an increased capital works deduction rate of 4% per year (up from 2.5%), reducing the depreciation period from 40 years to 25 years. This applies to projects where construction commenced after May 9, 2023.
How to Calculate Capital Works Depreciation Rate
| Construction Year | 21 Aug 1979 | 20 July 1982 | 22 Aug 1984 | 18 July 1985 | 16 Sept 1987 | 27 Feb 1992 to Present | |
|---|---|---|---|---|---|---|---|
| Structural Improvements | 2.5% | ||||||
| Residential | 4% | 2.5% | |||||
| Offices, Warehouses & other Commercial | 2.5% | 4% | 2.5% | ||||
| Manufacturing | 2.5% | 4% | 2.5% | 4% | |||
| Hotels, Motels & Guest Houses | 2.5% | 4% | 2.5% | 4% | |||
| Key: | 2.5% | 4% |
|---|
Plant & Equipment (Division 40)
Plant and Equipment assets, which are considered depreciating assets, are generally detachable items with shorter lifespans compared to structural elements. These items allow for accelerated depreciation claims due to their faster wear and tear.
Examples of Depreciating Assets and Plant & Equipment:
Residential Properties: Ovens, range hoods, air-conditioning units, smoke alarms, downlights, electric garage doors. Commercial Properties: Fire hydrant boosters, hot water units, door closers, coffee machines, warehouse cranes.
There are two questions we always ask investors to answer:
- When were your assets installed?
- What type of assets do you own or lease?
It’s worth noting that as of May 9, 2017, investors purchasing second-hand residential properties can no longer claim depreciation on existing Plant & Equipment unless substantial renovations have been completed.
One common approach to depreciating these assets is the declining balance depreciation method, which allows for higher deductions in the initial years of ownership.
Meanwhile, new Plant & Equipment in second-hand properties remain eligible for deductions.
Methods of Calculating Depreciation
When it comes to calculating depreciation, property investors have two main methods to choose from: the prime cost method and the diminishing value method.
The prime cost method assumes that the value of a depreciating asset decreases uniformly over its effective life.
This method claims a fixed amount each year, calculated using the formula: Asset’s cost × (days held ÷ 365) × (100% ÷ asset’s effective life).
On the other hand, the diminishing value method assumes that the value of a depreciating asset decreases more rapidly in the early years of its effective life.
This method claims a percentage of the asset’s cost each year, based on the formula: Base value × (days held ÷ 365) × (200% ÷ asset’s effective life).
Understanding these methods is crucial for property investors when calculating depreciation to maximise their tax benefits.
What’s A Tax Depreciation Schedule?
A tax depreciation schedule is essential for property investors looking to maximise their tax depreciation deductions.
This comprehensive report, prepared by a qualified quantity surveyor, outlines the tax depreciation deductions that can be claimed on an investment property. The schedule considers the property’s construction costs, age, and condition, as well as the value of its fixtures and fittings.
By providing a detailed breakdown of the depreciation deductions that can be claimed over the life of the property—typically 40 years—a tax depreciation schedule ensures that property investors can fully leverage their tax benefits and optimise their financial returns.
Legislated Changes to Property Tax Depreciation Schedule
Property investors who sign the contract to purchase a second-hand residential after 7:30 pm on the 9th of May 2017 are no longer eligible to claim depreciation on plant and equipment (division 40).
Investors can still claim tax depreciation on brand-new plant and equipment like carpet and air-conditioning units. Utilising an investment property depreciation calculator can help investors understand the impact of these changes on their potential tax deductions.
Additionally, the instant asset write-off threshold is now $20,000 per asset for small businesses with aggregated turnover under $10 million. This applies to assets first used or installed between July 1, 2023, and June 30, 2025.
Built-to-rent developments are also now eligible for an increased capital works deduction rate of 4% per year, up from the previous 2.5%. This change reduces the depreciation period from 40 years to 25 years for projects where construction commenced after May 9, 2023.
Common Mistakes to Avoid
When claiming depreciation deductions, property investors often make several common mistakes that can lead to missed tax savings or even penalties.
Not Claiming Depreciation At All
One of the most significant errors is not claiming depreciation at all. Many investors are unaware of the depreciation deductions they are eligible for, resulting in substantial missed opportunities for tax savings.
Misplacing or Losing Records
Another frequent mistake is failing to keep accurate records of your property’s assets and their values. Calculating depreciation accurately becomes challenging without precise documentation, which can lead to incorrect claims and affect your tax deductions.
Using the Wrong Method
It’s also essential to use the correct depreciation method for your assets. The prime cost and diminishing value methods have different formulas and requirements. Using the wrong method can result in incorrect claims, potentially reducing your tax benefits. Understanding the nuances of each method and applying them correctly is vital for maximising your depreciation deductions.
Not Consulting a Qualified Quantity Surveyor or Professional
Lastly, consulting with a qualified quantity surveyor or tax professional is crucial. These experts can help you navigate the complex rules and regulations surrounding depreciation, ensuring that you’re claiming the correct deductions.
They can also assist in preparing a comprehensive tax depreciation schedule, which is indispensable for optimising your tax savings.
By avoiding these common mistakes, property investors can ensure they are fully leveraging their depreciation deductions and enhancing their investment returns.
When Can You Claim Depreciation on Property?
You may be eligible for property depreciation benefits if any of the following scenarios apply:
- You own a brand-new residential property.
- Your property qualifies for building depreciation under Division 43.
- You’ve purchased a second-hand property with substantial renovations.
- You’ve installed new Plant & Equipment in a second-hand property.
- Your property is part of a Managed Fund or owned by a corporate entity (e.g., Pty Ltd).
- You’ve converted your Principal Place of Residence (PPOR) into a rental property before July 1, 2017.
- Your property is commercial or non-residential (e.g., manufacturing facilities or motels).
If you are unsure whether you qualify, it’s best to speak to one of our experts.
The majority of our investors claim an average of $7,500 in tax depreciation on their tax returns in their first year alone.
