For the average Australian, tax breaks are what make property investing affordable. Depreciation on investment property is one of the essential tax breaks out there. In this article, I’m going to look at depreciation on new properties.
If you’ve bought an existing property, check out Claim depreciation on an older investment property.
What is depreciation?
Depreciation is how much the Australian Tax Office (ATO) says assets decrease in value as they age. For example, on a $2,000 desktop computer they allow four years. This gives the owner a $500 tax deduction per year over those four years.
Property investors claim depreciation in two ways:
The first is Capital works deductions
This is the cost of building the investment property (ie. the construction costs). This depreciation is spread over 40 years, the length of time the ATO says a building lasts before it needs replacing. For instance, a new building that cost $200,000 to build would let you make a $5,000 tax claim each year for 40 years (ie. 2.5% per year).
The second is Depreciating assets
The ATO’s definition of depreciating assets is:
"… an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. Depreciating assets include such items as computers, electric tools, furniture and motor vehicles."
For property investors, this might include light fittings, stoves, carpets and even the humble rubbish bin!
The ATO lists all items you can claim—and for how long. Known as ‘the effective life’, this is how long they say an asset lasts before it needs replacement.
For instance, carpet has an estimated ‘life’ of 10 years, a kitchen stove 12 years, and that bin will last 10 years.
How do I claim for ‘depreciating assets’?
You have two choices when claiming this tax break:
Prime Cost Method
This gives you an equal tax deduction each year over the item’s effective life.
Diminishing value method
This gives you higher claims in the first years of the item’s effective life, and smaller claims later on. Most investors opt for Diminishing value as it affords a higher depreciation rate earlier. Your accountant will advise which method’s best for you.
Why do property investors receive these tax breaks?
I believe there are two reasons. Firstly, there’d be a serious lack of rental properties without investors. Through granting tax deductions to investors, the government encourages a sufficient supply of these properties.
Secondly, these tax breaks encourage people to use property to secure their own financial future. This lessens the strain on public welfare and pension systems.
How do you claim depreciation?
I strongly recommend you engage a quantity surveyor. Some quantity surveyors are better than others so look for a specialist firm who’ll put the time in and actually visit your property.
Quantity surveyors are experts at assessing the value of construction work. They’ll provide you with a report on the rate of depreciation claimable on your property, and when you can claim it. Send the report to your accountant who’ll then claim it on your tax return.
For info on what you can claim, check out the Australian Tax Office’s (ATO), Rental Property 2014.
The information in this article has been written by Michael Sloan from The Successful Investor. While Mr Sloan has been careful to ensure the information is correct and accurate, Mr Sloan’s views are his own and do not necessarily represent those of National Australia Bank Limited ABN 12 004 044 937, AFSL and Australian Credit Licence 230686 (NAB). This information should not be relied upon as financial product advice as none of the information provided takes into account your personal objectives, financial situation or needs. NAB recommends seek the counsel of an independent financial advisor before making any investment decision.