As the owner of an investment property, you might be able to claim rental property depreciation on your next tax return. From property management fees to home renovations and improvements, understanding how to claim these items could help you save come tax time.
But you had better know what you’re doing: the Australian Taxation Office (ATO) has spent the last few years closely scrutinising the tax statements of investment property owners to ensure every claim they’re making is legitimate.
Here’s what you need to know about claiming depreciation of residential rental property.
What is investment property depreciation?
Investment property depreciation is a deduction you can make on your taxable income relating to the wear and tear of your property over time. By claiming depreciation as a deduction, investors can reduce their taxable income and, in turn, improve their cash flow.
In Australia, the Australian Taxation Office (ATO) allows investors to claim depreciation as a tax deduction. That way, property owners don’t bear the whole cost of aging assets or structural deterioration alone.
How does investment property depreciation work in Australia?
As an investor, there are two main types of depreciation you can claim:
Division 43 - Capital works deductions Refers to the construction costs or structural elements of the property, including walls, roofs and fixed infrastructure. These expenses are generally claimed at a rate or 2.5% or 4% per year, spread over a 40- or 25-year period, respectively.
Division 40 - Plant and equipment depreciation Relates to removable items or fixtures, like carpets, blinds, appliances and furniture. Plant and equipment items are depreciated at varying rates based on the asset’s effective life.
Importantly, there are certain expenses that you can’t claim as a landlord. You won’t be able to claim borrowing expenses that you paid to take out your investment loan, or second-hand items that were already in the property when you bought it or lived in it as a primary residence.
Before you can start claiming deductions for your investment property, you’ll need to get a depreciation schedule that details the deductions you can claim over the life of your investment property. While you’ll need to engage a professional quantity surveyor to complete a schedule for you, the good news is that this cost is also tax deductible.
If you purchased a property that was designed to be an investment - like an off-the-plan unit, for example - the developer may have already prepared a depreciation schedule as part of the sale process. Check your files!
New vs. established properties: What’s the difference?
The rules around claiming depreciation on second-hand assets changed on the 9th of May 2017, meaning that depreciation on a new investment property can generally be claimed at a higher rate.
Here’s a quick breakdown of the key differences in depreciation between established and new properties.
Depreciation on an established property
Since the introduction of the new legislative changes in May 2017, the depreciation opportunities for older, established buildings are now limited. That said, you might still be able to take advantage of depreciation benefits when it comes to:
Capital works deductions:
You might be able to claim capital works deductions for structural components on buildings built after the 15th of September 1987, or
Deductions for renovations or home improvements that were completed after this date on older buildings, so long as you have records of the costings.
Plant and equipment deductions:
While you can no longer claim depreciation on existing plant and equipment for properties purchased after the 9th of May 2017, you can still claim depreciation for assets purchased for your investment property after this date.
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Depreciation on a new-build investment property
As a general rule, owners of newer investment properties will typically be able to claim higher depreciation deductions across both capital works and plant and equipment. Here’s how.
Capital works deductions:
Investors can claim a percentage of the property’s construction cost (usually 2.5% annually) for up to 40 years, but because construction costs increase over time, the deductions on newer builds are higher.
Plant and equipment deductions:
There are over 6000 different depreciable assets listed by the ATO, including items like carpets, blinds, smoke alarms, air conditioning systems and other appliances. So long as these items are new, investors can claim depreciation without restrictions.
To make life easier for owners of new investment properties, builders and developers often provide detailed cost breakdowns so quantity surveyors can quickly prepare depreciation schedules.
How to calculate depreciation on an investment property
The ATO uses two methods when it comes to calculating depreciation on a rental property: the prime cost method and the diminishing value method.
Under the prime cost method, also known as the straight line method, an asset is evenly depreciated over its effective life. This approach provides consistent deductions each year, making it ideal for investors who prefer steady tax benefits over the long term.
The diminishing value method assigns a higher depreciation rate to assets during the initial years of ownership. Under this method, investors can maximise deductions in the short term. This can help to improve cash flow during the early stages of property ownership.
Before calculating depreciation on your investment property, it’s essential to obtain a professional depreciation schedule from a quantity surveyor. This schedule breaks items down by capital works and plant and equipment and identifies all depreciable items, their values and effective lives based on ATO guidelines. Not to mention, having an accurate depreciation schedule is also a key aspect of maintaining compliance with relevant regulations.
A good quantity surveyor will work with you to understand your individual property investment strategy to help you maximise depreciation and minimise costs. Once you have your schedule, all that’s left to do is hand it over to your accountant come tax time and they’ll take care of the rest.
Benefits of investment property depreciation
As a landlord, you can take advantage of a number of benefits when it comes to claiming depreciation on your investment property, including:
Reduce taxable income: Claiming depreciation effectively reduces the amount of income that’s subject to tax, in turn reducing your annual tax bill.
Improve cash flow: Saving money on your taxes allows you to increase your disposable income, which can be put toward reinvestment or other expenses.
Claim non-cash deductions: Depreciation doesn’t necessarily require out-of-pocket expenses, unlike repairs or upgrades, but still provides tax benefits.
Offset wear and tear: Claiming for wear and tear provides compensation for the natural decline in value of the building and its assets over time.
Common depreciation mistakes to avoid
Depreciation can be a powerful tool to reduce costs, boost cash flow and increase long-term financial returns on investment properties. That said, it can be a complex process to navigate, with many landlords falling victim to a number of common mistakes, like:
Overlooking professional depreciation schedules,
Failing to claim depreciation on eligible assets or the building structure,
Claiming depreciation on ineligible items,
Incorrect record keeping, and
Misunderstanding ATO rules regarding plant and equipment.
To make the most of your investment property’s depreciation deductions and avoid potential pitfalls, it’s essential to work with professionals, including qualified quantity surveyors and tax accountants. If you have any questions about financing an investment property, book an appointment with an Aussie Broker.