How Depreciation Deductions Can Reduce Taxes for Australian Property Investors

January 26th, 2024

Depreciation: An Essential Tax Strategy for Property Investors

Depreciation is one of the most valuable tax deductions available to Australian property investors. By claiming depreciation, investors can legitimately reduce their taxable income from rental properties. This allows them to pay less income tax and maximize rental property cash flow.

In this guide, we will explain the basics of depreciation and how it benefits investors from a tax perspective. We’ll also outline the major types of property depreciation deductions and provide tips on how investors can fully utilize them.

What is Depreciation?

Depreciation refers to the wear and tear over time of a rental property’s assets. As buildings and assets like carpets, blinds, and appliances get older, they lose some monetary value each year. Australian tax law recognizes this decline in value by allowing property investors to claim yearly depreciation deductions.

These non-cash deductions reduce the amount of tax owed on rental income. By lawfully minimizing tax obligations, investors get to keep more income to service mortgages, bills, and other expenses. This supports property cash flow and investment feasibility.

There are two main categories of depreciation that investors can claim:

  • Capital works deductions – these relate to the structural elements of a property like walls, wiring, plumbing, windows, and roofing. Capital works deductions have very long effective lifespans.
  • Plant and equipment depreciation – this covers easily removable assets added to a property like ovens, dishwashers, carpet, and air conditioning units. These shorter-lived assets get replaced more frequently.

Having both capital works and plant and equipment depreciation maximizes the deductions an investor can take.

Who Qualifies for Depreciation Deductions?

Depreciation tax deductions apply to all Australian residents who generate assessable rental income. It does not matter if you own one property or a large portfolio – depreciation allows every investor to optimize their tax position.

There are some specific rules around depreciation eligibility that investors should understand:

  • For brand new properties, investors can claim both capital works and plant & equipment deductions from the moment the asset is available to rent out. All expenditure on construction materials and assets can be deducted over time.
  • For existing properties, plant and equipment is still claimable on any items left by previous owners. However, capital works deductions may be limited depending on who previously rented out the property. Quantity surveyors provide guidance here.
  • Properties purchased within 15 years of being built can qualify for some residual capital works deductions. This recognizes there is still useful lifespan left in structural elements.

In essence, every Australian property investor leasing out a residential asset should utilize depreciation. The tax savings it creates supports keeping more rental income.

The Significant Tax Savings Depreciation Provides

Utilizing all available depreciation deductions could save the average investor thousands in tax every year. It also accumulates substantial tax deferrals over long-term ownership periods.

Let’s quantify some scenarios to show the power of maximizing depreciation:

  • The average Australian investor claims $2,000 to $4,000 in the first year of deductions on a $500,000 property. This saves between $600 to $1,200 in income tax when combined with other costs.
  • An investor with a $2 million dollar portfolio could easily deduct between $15,000 to $30,000 in depreciation expenses each tax year. At a 30% tax rate, this would reduce tax payable by $4,500 to $9,000 per year.
  • Over a 10 year period, an investor’s cumulative depreciation deductions could exceed $100,000. At 30% tax, that equates to over $30,000 in tax deferred or saved.

With the substantial sums involved, depreciation deductions should be a non-negotiable part of an investor’s tax strategy. The savings help improve cash flow and maximize wealth.

An Introduction to Capital Works Deductions

Capital works refers to the structural aspects of a property asset – its fixed parts like walls, wiring, windows, plumbing, and roofing.

As these building shell components age, legislation recognizes they lose value over decades of wear and tear. Thus, investors can make annual capital works deduction claims that reflect this gradual decline.

Some key aspects of capital works depreciation include:

  • Capital works deductions have very long effective lifespans – usually 40 years for residential buildings.
  • Constructing a new property or extensively renovating establishes the total pool of capital works deductions. This pool gets claimed bit-by-bit over 4 decades.
  • The construction costs of a building’s fixed structural elements drives the total capital works deduction available. Higher construction expenses mean larger deductions.
  • For existing properties, determining remaining capital works deductions involves tracing previous claims by past owners and tenants. Specialist quantity surveyors provide guidance here.

Capitalizing on capital works tax deductions involves understanding what construction costs apply to the structural shell of a property. This is where quantity surveyors add specialized value, as we outline later.

Understanding Plant and Equipment Asset Depreciation

In contrast to the longer-lived structural elements, plant and equipment relates to shorter lifespan assets attached within and around a property.

Plant and equipment includes removable items like:

  • Air conditioning units
  • Carpets and linos
  • Curtains and blinds
  • Appliances like ovens, dishwashers, and cooktops
  • Tap fittings and plumbing accessories
  • Furniture like beds and couches provided with rented properties

Owners can claim deductions for plant and equipment based on set depreciation rates via the Australian Tax Office (ATO). Alternately, owners in some industries may source better plant and equipment depreciation rates.

Common practice is to group low-value plant and equipment assets into a pool, attracting a 30% deduction rate each year. More expensive individual items get a depreciation schedule customized by a qualified quantity surveyor – ensuring maximum deductions.

Getting a Depreciation Schedule and Making the Most of Your Deductions

A depreciation schedule lists out all eligible capital works and plant and equipment deductions available to investors in their specific rental property. Schedules optimize an investor’s tax deductions and are created by qualified quantity surveyors.

There are several major benefits for investors in obtaining an up to date depreciation schedule, including:

  • Ensures you claim every tax deduction legally available, maximizing deductions
  • Helps accurately forecast tax obligations and plan finances
  • Provides vital documentation if audited by the ATO
  • Can be the difference between a positively or negatively-geared property

Using qualified specialists like those at Empire 8 Property brings additional value through their assessment methodology including:

  • Physically inspecting rental properties to capture all on-site plant and equipment
  • Forensically researching a building’s ownership history to determine available capital works deductions
  • Knowledge of latest industry rulings or better depreciation rates for assets
  • Detailed review of construction contracts and payment schedules

Obtaining a reliable depreciation schedule lays the foundations for substantial tax savings year after year. Industry specialists like Empire 8 Property prepare schedules with a fixed fee from $470.

Frequently Asked Questions About Depreciation

Many Australian property investors have more specific queries about using depreciation schedules and deductions to improve their tax position. Below we answer some common questions:

Q: I inherited an investment property from a relative – can I still claim depreciation?

A: Yes, inherited properties qualify for deductions so long as they generate rental income. As set ownership periods dictate capital works eligibility, a new depreciation schedule is recommended.

Q: Do I need to be charging market rent to claim my deductions?

A:No. Tax deductions like depreciation apply on any residential rental income, even discounted rent to family or friends. Ensure declared rental income aligned to ATO benchmarks.

Q: Can I claim the full purchase costs of items like a washing machine upfront?

A:No. Plants and equipment like appliances must be depreciated over time according to set schedules and rates. Your quantity surveyor will provide guidance here.

Q: I missed some deductions one tax year – can I catch up claiming them in future years?

A:Unfortunately not. Deductions must be claimed in the appropriate tax year they relate to. Staying on top of record keeping is essential with rental properties.

Hopefully this overview gives investors confidence in maximizing their depreciation deductions. As outlined, substantial tax savings apply – so ensure you capitalize on this important property tax rule each tax season. If you have any other questions about reducing your property tax liabilities, please contact Empire 8’s tax advisory division for clear answers from investment specialists.