Tuesday, 24 January 2012

How does depreciation work with an investment property


How does depreciation work with an investment property?

Last Updated 5 September 2011

What is depreciation?

Depreciation represents a reduction in the value of an asset due to usage over time. So if you buy a brand new investment property while the value of the land may increase and your property’s total value may increase over time some of the building features or fixtures in the property will decline in value. One way the ATO will allow you to account for this is by claiming a tax deduction for the depreciation each year. There are two main types of depreciation you can claim each year for your investment property on your tax return.
  1. Construction Costs
  2. Fit-Out Costs

Construction Costs

Also known as building & construction cost. For rental properties purchased after Sep 15 1987 you can claim 2.5% of the construction costs each year over 40 years from the date the construction commenced.

How does claiming construction cost depreciation affect capital gains tax?

Well if you are going to claim construction costs as a tax deduction each year the ATO would not like you to leave the cost base of the property the same as what you bought it for. Construction costs are classified as ‘Capital Works Deductions’ by the ATO and so reduce the cost base of your property. The ATO wants you to reduce your cost base by the amount of any of these ‘capital works deductions’ you have made. So you have to reduce the properties cost base by the amount of depreciation you have claimed. So it kind of works in a sense that claiming depreciation will reduce your taxable income now but lead to an increased capital gain later.


These are items such as fridges, curtains, TVs etc. These are deductible each year. The deduction can be calculated using 2 methods:
  1. Prime Cost Method
  2. Diminishing Value Method

Prime Cost Method

This will lead to an equal deduction in each year. The formula used to calculate the deduction is: Deduction = Fit-out Cost x (100% / Asset's Effective Life) An asset’s effective life is how long it can be used for by the property for a taxable purpose.

Diminishing Value Method

This method will lead to larger depreciation claims in earlier years and smaller depreciation claims in later years when compared to the prime cost method. Deduction = base value x (days held / 365) x (200% / asset’s effective life) The base value is the fit-out value at the beginning of the year. So the base value will change each year due to adjustments to account for last year’s depreciation.

Want to calculate your income tax saving from claiming depreciation?

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