Getting a Home Loan in Australia if you're living overs...
29 Nov 2023
While it’s true property prices generally trend upwards, it’s the value of the land the home is on that grows. Over time, wear and tear eats away at the value of the dwelling itself. On an investment property, you can often claim house depreciation as a tax deduction. Claiming the full extent of your investment property depreciation can save you thousands of dollars at tax time, so it’s important to get your head around it.
Generally speaking, tax deductions are a means to claim back costs incurred in the process of making money. The rationale is that it would be unfair for the ATO to tax someone on any income that was spent on expenses necessary to earn that income.
These deductions are either written off instantly (the full cost deducted from your taxable income in the purchase year) or spread over the effective life of the asset, depending on how much it is worth. For example, if you spend $900 on a work phone, you can subtract the full amount amount from your taxable income that year. On the other hand, a construction company that spend $200,000 on a bulldozer will need to claim this cost back over several years through depreciation.
You’ve spent money on an investment property for the purpose of generating income, so the proportion of this cost spent on depreciating assets can be claimed back. Instant write offs do not apply to property investors, so these deductible costs are applied through depreciation. Since the value of the land itself isn’t likely to decline over time, it is classed as a capital asset to which deductions don’t apply.
Generally, there are two types of allowances you can claim.
This refers to the cost of building the property. According to the ATO, a building has a lifespan of 40 years before it needs replacing, so the depreciation costs are spread accordingly. It’s a slight oversimplification, but lets say that the construction costs of a dwelling were $100,000. The owner of the property could make a yearly tax deduction of $2,500 for 40 years.
The ATO regards any asset with a limited effective life that can reasonably be expected to decline in value over time as depreciable. There are likely several features of your investment property besides the structure itself that this applies to. Examples include:
Using the ATO depreciation calculator, you can see how long an assets effective life. For example, an air conditioning unit has an effective life of 5 years. That means that for each of those five years, you could make a tax deduction of 20% of its value.
To make sure you are claiming as much as you are eligible for, it’s a good idea to hire a professional to put together a depreciation schedule for your rental property. This is a comprehensive report, usually prepared by a specialist Quantity Surveyor outlining all depreciation deductions claimable for a residential investment property, separating capital works and other depreciating assets. This will likely cost between $300 and $800. If there are any renovations, repairs or replacements of assets on the property, the depreciation schedule will need to be updated.
Once you have a depreciation schedule, there are a couple of different ways that depreciation can be claimed.
Claiming a fixed percentage of the asset's value every year for its effective life is called the prime cost method. Lets say your property includes an aircon that costs $2,500. Since the effective life of an aircon unit is five years, using the prime cost method would mean you claimed a $500 tax deduction each year over the life span.
The alternative is a slightly more complicated calculation that calculates the yearly decline as a proportion of the assets current value, not the original cost, and double the depreciation factor. This method means there are higher claims for the first couple of years of holding the property/asset that get progressively smaller each year.
Lets return to the $2,500 air con. In the first year, the current value is $2,500, so if the depreciation factor is 20%, you double this to 40%. The claim amount becomes $1,000. In the second year, the asset is now valued at $1,500 (the previous value minus the depreciation amount). You then apply the 20% depreciation factor once again, and the asset depreciates by $600. This process keeps going until the asset is valued at $0.
|Asset value at start of year||Prime cost||Diminishing value|
Many investors opt for diminishing value as they can claim higher amounts earlier on, which is helpful if they decide to sell a few years after building or buying.
If you’re looking to begin your investment property empire, loans.com.au have a range of investment property loans that you can check out. Alternatively, should you want more information, you can schedule an appointment with one of our lending specialists.
The only age-limited part of depreciation is ‘capital works’, which is how much it cost to build the property. If your property was built after 15 September 1987, you’re able to claim 2.5% depreciation each year until it is 40 years old. You can claim tax breaks on depreciating assets i.e. fixtures and fittings no matter how old the property is, however.
Depreciation is a tax deduction available to everyone who owns property for the purpose of producing income, whether it is doing so or not. If there are no tenants, you’ll need to show that the property is being held to generate income, and you have a reasonable expectation that it will do so in the future.
Generally speaking, if you rent out a room in your house, you can claim depreciation on the portion of the house used for rental purposes. This is usually calculated as a percentage of the total floor area of the house. For example, if the rented room takes up 10% of the total floor area of the house, you can typically claim 10% of the depreciation.
When you sell an investment property, you are required to pay capital gains tax on the profit you make from the sale, which is calculated by subtracting the cost base (purchase price, buying costs and improvement costs) from the sale price. As you claim depreciation on the property over the years, the cost base decreases, which increases the capital gain, so you may be liable for more capital gains tax.
The ATO usually allow up to two years from the date of notice of assessment for the relevant year for you to amend your tax return. If you have a depreciation schedule done up and there are extra claims you could be making, you will be able to backdate up to this two year mark.
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