Don't Drink the Coolaid on Depreciation

Rental Properties Have to be More Than a Tax Deduction

A rental property can be a worthwhile investment, in the right (and very specific) circumstances. However sometimes claiming depreciation can be held up as a good reason to invest. If it makes your top five reasons for buying a rental then you might want to think again, and this article will explain why.

The Tax Deduction is an Expense


You may have seen something like this:



Firstly, reasonable assumptions would include a more normal long term interest rate, periods without a tenant and all the costs (like stamp duty).

But what is my issue with highlighting the depreciation?

Depreciation has more consequences than just a reduction in the income tax you pay in this financial year.

Depreciation is the loss you are making on owning something that is going down in value (and will probably need to be replaced). Yes – you might not have had any cash out of pocket this year, but eventually you are going to need to replace the oven, hot water system or carpets. At that stage you have a cost, without the tax deduction.

Here is an example of an $830 tax deduction from depreciation given by the ATO:
ato table

As with most things tax, there are different rules that apply to purchases at different dates and there are two methods of depreciating an asset that your accountant can give advice on.

The other deduction that people are sometimes talking about when they discuss depreciation is the “capital works deduction”. This is an acknowledgment in the tax law that the building on the land is not going to last forever and is in fact losing value.

For example, if the construction of the house cost $200,000 you may be able to claim a deduction of $5,000.

But don’t forget your house is a year older and arguably less valuable. Hold it for long enough then you will need to replace the roof, driveway, etc, etc. This deduction again is not a free kick.

So – you should not just look at the deduction and ignore the expense.

The Tax Deduction Leads to a Tax Bill


But this is not the only issue. You have to consider Capital Gains Tax (CGT).

Look back at the example:

Let’s say in the above example, you purchased this property for $500,000 and sell it for $500,000 (ignoring stamp duty and real estate agent costs). You might think, no gain, no loss, no capital gain tax. Well, this is not true.

If you claimed depreciation, then you, in fact, didn’t buy a property for $500,000. You bought a property for $450,000 with $50,000 of depreciable “stuff” (known as plant and equipment) in it. By putting $5,000 of depreciation into the return you are telling the tax office that “stuff” is now worth $45,000. This will affect your CGT calculations.

If you claim a capital works deduction again the CGT calculations are affected. If you also claim a $5,000 “Capital works deduction” then the ATO will deem the effective purchase price (cost base) of the property at $445,000.

So when you sell for $500,000 you are selling a property for $455,000 and plant and equipment for $45,000. Capital Gains will apply on the property gain from $445,000 to $455,000. This will create a $10,000 gain subject to CGT.

The one silver lining is that if you have held the asset for more than 12 months you should get a 50% reduction in the capital gain.

All of this, to a large extent, negates the “no out of pocket expense” claim above.

Depreciation and Capital Works Deduction, although something that you should generally claim, should not be the cornerstone of your investment strategy.


Article by Matt Boxer - GPA Financial Planning

Tax Advice Provided by David Boxer - Registered Tax Agent. 

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