Depreciation and negative gearing are two powerful tools in the arsenal of property investors in Australia. When combined, they can significantly enhance the tax efficiency of an investment property. Depreciation allows investors to claim the decline in value of certain assets and building structures, while negative gearing involves deducting the cost of owning an investment property from your overall income, potentially creating a tax loss.
Under Division 40 of the Income Tax Assessment Act 1997, investors can claim depreciation on plant and equipment, such as appliances and fittings, over their effective life. Division 43 covers capital works, allowing deductions for the structural elements of a building. The primary misconception is that depreciation is an upfront deduction; instead, it is claimed over time, aligning with the asset's effective life.
To see how this plays out, consider a 2010-built 3-bedroom house in North Melbourne with a purchase price of $850,000. By claiming depreciation on plant and equipment, as well as capital works, you might reduce your taxable income by $10,000 in the first year. If your property is negatively geared, meaning your rental income is less than your mortgage interest, maintenance, and other costs, this depreciation can increase your tax refund. At a 37% marginal tax rate, this could enhance your refund by $3,700.
In our experience reviewing thousands of properties across Australia, many investors overlook the full potential of depreciation schedules, often underestimating the deductions available. Another common oversight is not updating the depreciation schedule after renovations or improvements, which can lead to missed opportunities. Furthermore, some investors mistakenly believe that depreciation is only relevant for new properties, missing out on deductions for older properties with eligible capital works.
The answer can differ depending on your situation. For properties purchased after 9 May 2017, second-hand plant and equipment depreciation is not claimable, affecting the overall deductions available for negative gearing. Additionally, properties built before 1987 are not eligible for capital works deductions unless renovations were carried out. Ownership structure also plays a role; for instance, SMSFs have different rules regarding depreciation and negative gearing.
Given the complexities involved, professional advice is crucial. A Chartered Quantity Surveyor can provide a detailed depreciation schedule tailored to your property, while an accountant can ensure these deductions are correctly applied against your taxable income, optimising your tax position.
To maximise the benefits of depreciation and negative gearing, consider the following steps: