A guide to investment property depreciation

Depreciation is something that will help your bottom line come tax time. 

Just as you can claim wear and tear on a car purchased for income-producing purposes, you can also claim the depreciation of your investment property against your taxable income.

Seasoned property investors know all about this one. In fact, some will take depreciation into account before purchasing their next investment. But it’s not just for the pros. Anyone who purchases a property for income-producing purposes is entitled to depreciate the building and the items within it against their assessable income.

Seasoned property investors will take depreciation into account before purchasing their next investment.

But others are none the wiser, which means that, every year, thousands of dollars go unclaimed.

To make substantial savings, all property investors need to do is arrange a qualified quantity surveyor to inspect their home and prepare a report for their accountant.

So for anyone who’s unfamiliar with the process: it pays to learn.

Here’s a basic guide to property deprecation:

What is property depreciation?

Property depreciation is a tax break that allows investors to offset their investment property’s decline in value from their taxable income.

Claims on property depreciation will fall into one of two categories:

• Capital works allowance (Division 43) – covering the value of the building’s structure
• Plant and equipment depreciation (Division 40) – covering the value of removable items

Australian law allows investors to claim tax deductions on both the decline in value of the building’s structure and items considered permanently fixed to the property and the decline in value of plant and equipment assets found within it (think ovens, dishwashers, carpets and blinds).

Not only does it help you pay less tax, it’s a “non-cash deduction”, which means that you don’t have to pay for it on an ongoing basis; the deductions are built into the purchase price of your property.

All other deductions, such as interest levies, will hurt your hip pocket on an ongoing basis.

How to calculate property depreciation

Property owners have two ways of calculating depreciation on their assets:

1. Prime Cost

This method of calculating the depreciation of an asset assumes that it depreciates uniformly in value over its effective life.

To use this method the following calculation is used:

Asset’s cost × (days held ÷ 365) × (100% ÷ asset’s effective life)

The ATO provides guides on the effective life of claimable assets on its website.

For example, if the asset cost $10,000, you purchased it on July 1 and the effective life was five years then the following equation would apply:

$10,000 x (365 ÷ 365) x 20%

Which means you can claim $2,000 per year for five years.

2. Diminishing value

A diminishing value calculation assumes the asset depreciates quicker at the start of its life so you claim more in the beginning than in subsequent years.

Each year you claim for the item the base value reduces by that amount.

The formula used to calculate this method is: Base value × (days held ÷ 365) × (200% ÷ asset’s effective life).

For example, if the asset cost you $10,000, you purchased it on July 1 and its effective life was five years the following equation would apply:

10,000 x (365÷365) x 40% meaning you could claim the following amounts:

Year 1: Base value $10,000 x 40% = claimable amount: $4000

Year 2: Base value $6,000 x 40% = claimable amount $2400

Year 3: Base value $3600 x 40% = claimable amount $1440

Year 4: Base value $2160 x 40% = claimable amount $864

Year 5: Base value $1296 x 40% = claimable amount $518

How does depreciation work on investment properties

In Australia, when you purchase an investment property you’re treated as having bought a building as well as the various separate items inside, which the ATO calls ‘plant’.

The ATO requires property investors to separate values into ‘capital’ or ‘plant’, which means figuring out which items are part of the building and which items are removable and adding up their total values.

There are two main ways depreciation works when claiming investment property expenses.

1. Capital works

The easiest way of understanding what covers Capital Works is to think of the things that aren’t removable at the property. This includes walls, the roof, bathtubs, toilets etc.

Owners can claim wear and tear on these items at a rate of 2.5% for up to forty years providing the property was built after September 15, 1987.

2. Plant and equipment depreciation

Removable items such as appliances, carpet, window coverings are covered as part of the Plant and Equipment category.

Each item will be covered in the ATO’s list of around 6,000 items, which all have their own ‘effective life’, or claimable period (usually a number of years).

Can I claim depreciation on all investment properties?

There are four categories for claiming depreciation on investment properties:

Built before 18 July 1985

If construction on your property commenced prior to this date, you can only claim depreciation on Plant and Equipment.

Certain short-term rental accomodation is also covered.

Built between 18 July 1985 and 26 February 1992

If your residential property was built after July 1985, you will be able to claim both Building Allowance and Plant and Equipment.

The rates of deduction per claimable year for buildings constructed between these dates are between 2.5 and 4%.

Commercial and industrial properties are subject to varying cut-off dates.

Renovated properties

If your property was built after February 1985 and renovated you can claim depreciation, even if it was a previous owner who did the renovation.

You’ll need to know how much the renovation cost, however, as providing this information is an ATO obligation.

Where the cost of renovation is unknown a quantity surveyor can provide an estimation on cost.

Brand new and substantially renovated properties

You can claim a deduction for the decline in value of a depreciating asset in the property.

How do I get a depreciation schedule

Depending on when the property was constructed, you may have to hire different professionals to undertake the task of assisting you getting a depreciation schedule.

If your residential property was built after 1985, your accountant is not allowed to estimate the construction costs, nor are real estate agents, valuers or solicitors.

According to Tax Ruling 97/25, issued by the Australian Taxation Office (ATO), quantity surveyors are appropriately qualified to estimate the construction costs, when those costs are unknown.

According to Terry Aulich, Chief Executive Officer of the Australian Institute of Quantity Surveyors (AIQS), while accountants can offer general advice on other aspects of tax depreciation, construction costs and property depreciation are domains that require highly technical expertise.

“Quantity surveyors are specialists in the accurate measurement of construction costs with a view to maximising a client’s financial position in relation to their property assets. Only a fully-qualified quantity surveyor brings the appropriate education, experience and training to provide reliable figures upon which to base a property tax depreciation schedule,” says Terry.

“One doesn’t want to rely on best guesses when dealing with the ATO – especially when there is professional help available.”

Terry also suggests that clients should check the credentials of anyone claiming to be a quantity surveyor. He recommends that the first question clients should ask their quantity surveyor is whether they are a member of the AIQS, as membership indicates that a quantity surveyor has completed an accredited qualification.

Do I need an in person inspection?

The Australian Institute of Quantity Surveyors (AIQS) Code of Practice stipulates that site inspections are necessary to satisfy ATO requirements.

A trained quantity surveyor will ensure all depreciable items are noted and photographed. This guarantees you won’t miss out on any deductions. The documentation can then be used as evidence in the event of an audit.

It’s very common for quantity surveyors to liaise directly with the tenant or property manager in order to cause minimal disruption to the tenant. The best time to get a quantity surveyor to inspect your property is immediately after settlement and hopefully just before the tenant has moved in.

How much does a depreciation schedule cost and how long do they take?

The cost of preparing a tax depreciation schedule varies according to a number of factors, including the type of property you’ve purchased, its location and size.

Most of the leading quantity surveyors offer a money back guarantee to save you twice your fee in the first year, or they give you the report for free.

So you have absolutely nothing to lose – and many deducations to gain.

To sweeten the deal further, quantity surveyor fees are 100% tax deductible.

Your depreciation schedule will take approximately 2-3 weeks to complete, as long as the quantity surveyor can inspect your property without delay.

What happens if I just found out about this? Can I redo my tax returns

Yes, you can. Your accountant can amend your previous tax returns as far back as two years ago.

There are some exceptions, so contact your tax agent or the ATO for clarification.

How much will I save?

Each property is different and many factors must be considered when preparing a property depreciation schedule.

There are several depreciation calculators on the market, many of which can be found easily through a Google search for “depreciation calculator”.

Don’t pay for a property depreciation estimate; in my opinion, the best ones are free.