If you own a rental property, there’s a fantastic way to save money on taxes: depreciation. The idea is that the value of your property decreases over time due to wear and tear, and depreciation lets you claim that decline in value.
In this article, we’ll explain how depreciation works, how to calculate it, and how to claim it on your taxes. Let’s start!
What Is Depreciation?
Depreciation refers to the reduction in value of a property or its assets over time. This happens naturally due to factors like age, use, or weather. For example, the walls and roof of a building wear out over time, and depreciation helps account for this. While the land under your property doesn’t lose value, the building does.
For tax purposes, depreciation is a great way for property owners to reduce their taxable income. By claiming depreciation, you can lower the amount of money you’re taxed on.
Does Your Property Qualify?
Before you can calculate depreciation, you need to make sure your property qualifies. Here are the key requirements:
- You Own the Property: The property must be in your name.
- It’s Earning Income: You must be renting it out to earn money. If you live in the property or use it for personal purposes most of the time, it likely doesn’t qualify.
- It’s Used for Rental Purposes: The property must be used to generate income, like a rental home or apartment.
- It Lasts Over One Year: The property should have a lifespan of more than one year.
If your property meets these requirements, it’s eligible for depreciation.
How Is Depreciation Calculated?
In Australia, the most common way to calculate depreciation for rental properties is straight-line depreciation. This method divides the cost of the building into equal parts and claims the same amount each year over the property’s useful life.
Furthermore, estimate your property’s value by rental appraisal online. Additionally, separating land and building costs, and assessing rental income, are crucial for accurate depreciation calculations and tax planning.
Here’s how to calculate it:
- First, Find the Building’s Value (Basis)
- The basis is the cost of the building, excluding the land. For example, if you bought a property for AUD 400,000 and the land is worth AUD 100,000, the building’s value (basis) is AUD 300,000.
- Second, Determine the Depreciation Period
- In Australia, properties built after September 15, 1987, are eligible for depreciation at a rate of 2.5% per year for up to 40 years. If your building is worth AUD 300,000, you can claim AUD 7,500 per year (300,000 × 0.025).
- Finally, Consider Fixtures and Fittings
- Items like carpets, appliances, and air conditioners also depreciate, but they follow a different schedule, usually based on their lifespan, which may vary from 5 to 10 years.
What About Improvements?
If you’ve made any improvements to the property—like installing new appliances or replacing the roof—you can also claim depreciation on these items. Here’s how:
- Appliances: Depreciate over 5 years.
- Carpets and Fittings: Depreciate over 5-10 years.
- Roof Replacements: Depreciate over 27.5 years.
- Building (Capital Works Deduction): Depreciate at 2.5% per year for 40 years.
Make sure to keep good records of any improvements you make, as they will increase your depreciable basis.
How to Claim Depreciation
In Australia, you don’t need to fill out a specific form like in other countries. Instead, you claim depreciation as part of your tax return through the Australian Taxation Office (ATO). If you use tax software or an accountant, they will usually handle this for you.
If you’ve owned the property for years but haven’t claimed depreciation yet, don’t worry! You can still go back and amend your previous tax returns to claim the missed deductions. It’s worth the extra paperwork.
Benefits of Depreciation
Claiming depreciation can significantly reduce your taxable income, which lowers the amount of tax you owe. Nevertheless, keep in kind the following:
- Depreciation Recapture: If you sell the property, the ATO might tax the depreciation deductions you’ve claimed. We call this depreciation recapture. While this may sound concerning, the savings you get from claiming depreciation while owning the property usually outweigh the taxes you’ll pay when selling.
Depreciation is one of the best ways to reduce the tax burden on your rental property. So, by understanding how it works and keeping detailed records, you can take advantage of this valuable tax break.
Furthermore, if you’re unsure about the rules, don’t hesitate to seek help from a tax professional to ensure you’re claiming all the deductions possible.
