The Upside of Depreciation for Property Investors

When most people hear the word "depreciation," they think of it as a loss or reduction in value over time. And that's essentially correct - depreciation refers to the gradual decrease in an asset's worth due to age, wear and tear. 

However, for property investors, depreciation can actually work in their favor come tax time. In Australia, depreciation represents one of the biggest potential tax deductions available to those who own income-producing properties. It allows investors to offset the deterioration of their property and belongings against their taxable income.

So while depreciation does reflect a decline in the property's condition, it doesn't have to mean an actual financial loss for the owner. Instead, it translates into tax savings. Here's how it works:

What is Property Depreciation?

Depreciation is a non-cash deduction that property owners can claim on the assets within their income-generating properties. It is based on the premise that over time, buildings and their fixtures/fittings will inevitably deteriorate and lose value.

The Australian Taxation Office (ATO) provides guidelines on which items qualify for depreciation deductions. In general, claims can be made for:

  1. The property's structural components 
  2. Removable plant and equipment assets

Claiming Depreciation on Structural Components

Also known as capital works deductions, these cover the building itself and permanently fixed items like:

- Fences and retaining walls

- Doors, locks, handles  

- Built-in cupboards

- Bricks, mortar, walls, floors, wiring

- Extensions, alterations, improvements

- Other structural additions

Capital works can be depreciated over a longer timeframe than other assets - typically 40 years at a rate of 2.5% or 4% per year, depending on factors like construction date and usage.

Depreciation of Plant and Equipment 

Plant and equipment assets are those that are removable or mechanical in nature, such as:

- Air conditioning units

- Refrigerators, ovens

- Blinds, curtains  

- Hot water systems, heaters, solar

- Security systems

- Light fittings

The ATO determines the "effective life" of each type of plant/equipment asset. Depreciation deductions are spread out over this timeframe. For example, if carpets have an 8-year effective life, you can deduct 25% of their cost for 8 years.

Calculating Depreciation Deductions

There are two common methods for calculating depreciation deductions:

  1.   Diminishing value method - Higher deductions earlier, lower later on to account for decreasing value over time.
  1.  Prime cost method - Equal deductions each year over the asset's effective life.  

If an asset is worth under $300, you can claim the full cost as a deduction upfront.

Getting a Depreciation Schedule

To claim depreciation, you'll need a quantity surveyor to prepare a tax depreciation schedule. This report lists all plant/equipment assets and estimates their depreciated value over the effective life. It also calculates capital works deductions.

Ideally, get a depreciation schedule done right after purchasing the property to capture its exact condition. Then provide it to your accountant at tax time.

Be sure to update the schedule if you renovate, as it can impact which deductions you can claim.

Key Takeaways

- Depreciation is a way for investors to claim deductions for the wear and tear on their property over time

- It can be claimed on structural building components and removable plant/equipment assets

- Have a quantity surveyor prepare a depreciation schedule to calculate eligible deductions

- Depreciation helps reduce taxable income without an actual cash loss

While depreciation reflects a decline in value, it can be highly valuable for property investors at tax time. By taking advantage of these deductions, you can potentially save thousands and boost your investment returns.

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