New and seasoned property investors alike generally understand the tax deductions they’re entitled to, but there are also thousands of dollars to be saved through depreciation.
So, what is depreciation? And what does it mean to investors? Here’s everything you need to know.
What is property depreciation?
Investment property depreciation is a tax break that lets investors offset the decline in the value of an asset over time from their taxable income. It’s divided into capital works depreciation and plant and equipment depreciation.
In general terms, capital works depreciation covers the building, structural improvements including renovations, items permanently fixed to the building such as kitchen cabinets and doors, and other construction that improves your ability to make money, for example adding a pergola or pool that will attract increased rent.
Plant and equipment take into account things such as air conditioners, carpets, furnishings and curtains – things that can be removed. In most cases, the item needs to be new and purchased for the rental.
You can’t claim depreciation on an item you bought secondhand, or an item you already owned and decided to use in the rental.
Deprecation is based on a number of factors including when the capital improvement was made, when the item of plant or equipment was purchased, and the “effective life”.
You must also take into account the portion of the deduction that is for income-earning purposes (rent) versus personal use.
For instance, if you have a holiday home that you use three months of the year, and rent the remainder, you can only claim 75% of the deduction.
Rental property depreciation can only be claimed if you generally have the property available to rent.
In other words, you can’t claim the home is a rental because you put a sign up at the local community noticeboard, or put too many restrictions on renting it, such as only making your holiday home available off-season when no one wants to use it.
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What is the depreciation rate for property?
Capital works depreciation for investment properties is currently set at 2.5% over 40 years.
The Australian Tax Office has changed the way it calculates capital depreciation, however, with slightly different calculations depending if your house was built before 2004, between 2004 and 1 July 2019, and after 2019.
To claim a capital works deduction you must be able to provide:
- precise documents that show the construction costs, such as receipts or
- a report written by an appropriately qualified person.
If you can’t produce these documents, for instance, you paid cash to a tradesperson, or used a builder without an ABN, your claim probably won’t be approved.
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How many years can you claim depreciation?
When it comes to plant and equipment, depreciation is calculated based on effective life, taking into account how long the item can reasonably be expected to work, based on general wear and tear.
The ATO sets the effective life of hundreds of assets, ranging from as little as three years for the soap holder in the shower to eight years for carpet and 20 years for solar panels.
How to calculate depreciation of property
Depreciation on plant and equipment is calculated using two methods – prime cost method and diminishing value method.
Under the prime cost method, the decline in value is generally calculated as a constant percentage of the asset’s cost. It reflects a uniform decline in value over time.
The formula is: Decline in value = asset’s cost x (days held/365) x (100%/asset’s effective life)
Under the diminishing value method, the decline in value is calculated using the asset’s base value. The base value of an asset is broadly its cost plus any costs incurred on the asset since you first held it (say on improvements) less the decline in value of the asset up to the end of the prior year.
The formula for the diminishing value method is:
- If you started to hold the asset prior to 10 May 2006
Decline in value = base value x (days held/365) x (100%/asset’s effective life)
- If you started to hold the asset on or after 10 May 2006
Decline in value = base value x (days held/365) x (200%/asset’s effective live)
How can you claim maximum property depreciation?
Working out exactly what you can claim and how much, can be a bit of a minefield.
When purchasing an investment property, or deciding to rent out a home you’ve previously lived in as an investment, it’s a good idea to get a quantity surveyor to complete an inspection of your home to generate an investment property depreciation schedule.
Quantity surveyors are construction experts and will know exactly what to look for in terms of what can and can’t be depreciated.
The more information you can provide the better the financial outcome you can expect.
The quantity surveyor will want to know what improvements have been made, when and their value, and similar details for any plant and equipment.
If you’re buying, quiz the previous owner and ask for any records that may help, if it’s your own home, trawl through your receipts for proof.
You can, of course, generate your own investment property depreciation schedule.
The ATO has a wealth of online guides and calculators that can help, as well as online templates that you can use to keep track of your new expenses.
Instant asset write off
If you’ve purchased an item of plant or equipment for your rental that’s less than $300, you may be eligible for instant asset write off.
Rather than depreciating the item over its effective life, you can make a direct claim for the full amount (minus any personal use, naturally).
There is one caveat however, the item can’t be part of a set. So, if you’ve bought six new dining room chairs for a total cost of $1200 ($200 each) you will need to depreciate them.
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If you’re still struggling to makes heads and tails of your rental property depreciation, these guides from the ATO have a wealth of real-life examples that can help.
- Rental expenses you can claim now
- Rental Properties 2020
- Guide to Depreciating Assets 2021
- Rental assets you can claim over several years
Words by Erin Delahunty
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