How depreciation on investment property works

Ah, depreciation. It might not sound like the most thrilling topic, but trust us—when it comes to investment properties, depreciation can be a game-changer.

If you own an investment property or you’re thinking about diving into the property market, understanding how depreciation works is essential to maximising your returns. So, let’s break it down in a way that won’t make your head spin.

What exactly is depreciation?

In real estate terms, depreciation refers to the natural wear and tear that happens to a property over time. Just like your favourite pair of shoes or that trusty old car, things lose value as they age.

The good news? The Australian Tax Office (ATO) lets you claim this loss of value as a deduction on your investment property—meaning more dollars in your pocket come tax time. Who doesn’t love that?

Essentially, property depreciation is your way of saying, “My property’s getting a little older and less shiny,” and the ATO responding with, “Here, have some tax savings.” Neat, right?

The two types of depreciation

When it comes to depreciation on investment property, there are two main categories you need to know about: capital works depreciation and plant and equipment depreciation. While both involve deductions, they’re applied to different parts of your property.

1. Capital works depreciation

This relates to the structure of the building itself—think walls, roof, windows, and basically the bones of the property. If your investment property was built after September 15, 1987, you can claim a deduction based on the building’s construction costs. The ATO allows you to claim 2.5% of the construction costs per year for up to 40 years.

If your property is a little older (built before 1987), you might be out of luck with this particular deduction. But don’t despair—there’s still hope with the second type of depreciation!

2. Plant and equipment depreciation

This is where you can claim depreciation on all the bits and pieces that make your property liveable—things like appliances, carpets, hot water systems, and air conditioning units. Essentially, it’s everything inside your property that has a limited shelf life.

Unlike capital works depreciation, plant and equipment items have their own individual effective lifespan, determined by the ATO. Some items might depreciate faster than others, so you can claim a higher percentage earlier in their lifespan. For example, that shiny new oven you installed could give you more tax deductions in the first few years than, say, your carpets.

Pro tip: If you’ve recently purchased an older property, the depreciation for second-hand plant and equipment items can be limited. But don’t worry—newly purchased or renovated properties will allow you to claim more.

How does depreciation save you money?

Let’s get to the fun part: how depreciation on investment property can actually save you money. By claiming depreciation, you reduce your taxable income, which means you pay less tax.

Here’s a simple example:
Say you own an investment property, and after calculating your rental income minus expenses (like interest payments, council rates, and property management fees), you end up with a taxable income of $10,000. If you’re able to claim $5,000 in depreciation for the year, your taxable income drops to $5,000.

In this scenario, instead of paying tax on $10,000, you’re only paying tax on $5,000. See the difference? Over time, these savings can really add up and help improve your cash flow.

The role of a quantity surveyor

By now, you’re probably thinking, “How do I figure out how much I can claim in depreciation?” Great question. Enter the quantity surveyor. These are the folks with the expertise to estimate the construction costs of your property (even if you don’t have the original building plans) and assess the value of your plant and equipment.

A quantity surveyor will prepare a depreciation schedule for your property, which is like a personalised roadmap of what you can claim and when. This report details how much depreciation you can claim each year, and it’s crucial for ensuring you maximise your deductions without missing out on anything.

Pro tip: The cost of getting a depreciation schedule is tax-deductible, too!

Can you claim depreciation on renovations?

Absolutely! If you’ve done any major renovations on your investment property—whether it’s adding a new deck, upgrading the kitchen, or replacing an ancient hot water system—you can claim depreciation on these improvements. Even if you didn’t personally handle the renovation but the previous owner did, you might still be eligible to claim.

Keep in mind that depreciation for renovations works similarly to capital works and plant and equipment depreciation. For structural improvements, you’ll claim 2.5% per year, and for new assets, you’ll claim based on the item’s lifespan.

Depreciation and selling your property

While depreciation is a fantastic way to save on tax while you own the property, there is one little caveat to keep in mind when it comes to selling. The ATO requires you to account for any depreciation claimed during ownership when calculating capital gains tax (CGT). Essentially, the amount of depreciation you’ve claimed reduces your property’s cost base, meaning your CGT bill could be higher when you sell.

However, don’t let this scare you off from claiming depreciation. The tax savings you enjoy year after year can far outweigh any potential increase in CGT, and in the end, it’s still a winning strategy for many investors.

Wrapping it all up

Depreciation on investment property might sound a little daunting at first, but once you get the hang of it, it’s one of the most valuable tools in your real estate arsenal. By claiming depreciation, you can significantly reduce your taxable income and improve your cash flow—ultimately helping you make the most out of your investment.

Remember, though, that every property is different. To really maximise your depreciation claims, getting a professional depreciation schedule from a qualified quantity surveyor is the way to go. And if you ever need help with understanding the ins and outs of property investment, our team of Perth real estate agents is here to guide you every step of the way!