When buying an investment property, you need to consider that your costs will go far beyond the initial purchase price. You will also incur costs preparing the property for rental, and maintaining it in good-working order for your tenants. There may be initial costs fitting the property out, renovating or repairing it. Furthermore, over time wear and tear may mean the replacement of:
Building depreciation takes in more than just the structure itself. It also allows you to claim for depreciation of plant and equipment, which are the fixtures and fittings. This means you can claim a percentage of the money you spend on the building and its fixtures. Typically, this rate stands at 2.5%, which applies from the date of the property’s construction. Say you buy an investment property today for $500,000 that cost $200,000 to build back in 2000. Using depreciation of 2.5% against its original construction cost, you could claim up to $5,000 annually against the income you receive from rent. However you can only do this until 2040 as 40 years is the maximum time the ATO says a building can depreciate before it reaches its life expectancy.
The ATO allows you to claim against the cost of your furnishings for several years after you fit them. On top of that, you can claim further deductions for any furniture you fit in the property after the purchase date.
A depreciating asset will decline in value over the years as it has a limited life expectancy. A depreciation schedule allows you to figure out which items you can claim on, and how much value each will lose over time. Your schedule should include deductions for:
There are two ways of calculating depreciation, as detailed by the ATO:
The ATO has a calculator which you can use. Note this is general in nature and not specifically for individuals investing in property. A good tip: if you create myGov account and link it to ATO, you can save your records and calculations for use in your tax return. Find out more with the ATO depreciation calculator and see some working examples by visiting the ATO website.
Depreciation can help you save a lot of money on your tax bill in a financial year. However, you cannot claim this tax allowance more than once. Therefore, if you decide to sell your investment property you will have to deduct the depreciation you have already claimed from your cost base. Reducing your cost base will increase your gross capital gain and therefore the tax you will pay. Despite this tax liability, freeing up cash flow in the short term could also make good financial sense over the long term. For example it may enable you to pay down your debt faster, or make additional investments to generate new income streams. So it’s always worthwhile speaking to a professional to discuss your financial objectives and to decide which strategy will be most beneficial to your personal circumstances.
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