Depreciation and negative gearing are two powerful tools in the arsenal of property investors in Australia. When used effectively, they can significantly enhance the tax efficiency of an investment property. Depreciation refers to the tax deduction available for the decline in value of an asset over time, while negative gearing occurs when the cost of owning a property exceeds the income it generates, creating a tax-deductible loss.
Under Division 40 of ITAA 1997, investors can claim depreciation on plant and equipment, such as carpets and appliances. Meanwhile, Division 43 allows for deductions on capital works, like the building structure itself. The main misconception is that depreciation is merely a paper loss. In reality, it can transform a negatively geared property into a tax-efficient investment by increasing the tax-deductible loss.
To see how this plays out, consider a 2015-built 3-bedroom house in Geelong, purchased for $700,000. The property generates a rental income of $25,000 annually, but the expenses, including loan interest, property management fees, and maintenance, total $35,000. The initial cash loss of $10,000 can be further increased by claiming $6,000 in depreciation deductions (split between plant/equipment and capital works). This results in a total tax-deductible loss of $16,000, reducing a taxpayer's taxable income by this amount. At a 37% marginal tax rate, this could lead to a tax refund increase of $5,920 in the first year.
In our experience reviewing thousands of properties across Australia, many investors overlook the importance of obtaining a professionally prepared tax depreciation schedule. This oversight can lead to missed deductions. Additionally, investors often fail to reassess their depreciation claims annually, missing out on changes in asset values or new eligible deductions. Another common pattern is underestimating the impact of depreciation on cash flow, which can make a significant difference over the long term.
The answer can differ depending on your situation. For instance, properties acquired after 9 May 2017 have restrictions on claiming depreciation on previously used plant and equipment, impacting second-hand residential properties. Commercial properties, however, are not subject to the same restrictions and offer more flexibility in claiming depreciation. Furthermore, if a property is held in a Self-Managed Super Fund (SMSF), the tax benefits can differ due to the different tax rates applied.
Given these complexities, engaging both a Chartered Quantity Surveyor and a knowledgeable accountant is crucial. A QS provides a detailed depreciation schedule, ensuring all eligible deductions are claimed, while an accountant can integrate these deductions into your overall tax strategy, maximising benefits.