How depreciation works for a new investment property

Why depreciation matters for investors of new property?

Depreciation is what the Australia Tax Office (ATO) recognises as the gradual decrease in value of your investment property's assets over time. In simple terms, it reflects the fact that buildings and assets inside them lose value as they age.

For savvy investors building or buying a brand-new property, this isn't just a technicality; it's a financial strategy that can significantly improve your cash flow and tax savings. This is because depreciation allows you to claim the wear and tear on a new property as a tax deduction. What’s more, you can spread these costs over many years, so you can enjoy:

• Tax savings that can add up each year.
• Improved cash flow through reduced tax obligations.

Types of depreciation for new investment properties

Like old investment properties, a new property’s depreciation will also fall into these two main categories:

Capital works deductions

Capital works deductions relate to the construction costs of your new property, including walls, roofs, doors and built-in fixtures. It includes the building cost of your investment property and is claimed at a rate specified by the ATO, opens in new window over a specific time period (for instance, 40 years). This means if the construction cost of your new investment property is $250,000 and the depreciation rate is 2.5%, you’ll be able to claim $6,250 for 40 years from the date construction is completed.

Plant and equipment depreciation

This category covers removable or mechanical items in your property that have a limited lifespan such as:

• Appliances (for example dishwashers, ovens)
• Flooring (for example, carpets, vinyl)
• Blinds.

Plant and equipment items are depreciated over their ‘effective life’, which is set by the ATO, with different rates for different assets. Effective life is the estimated number of years an asset can produce income before it wears out.

Benefits of depreciation for new properties

New properties come with their own set of perks, especially when it comes to depreciation. Since they are brand new, the assets also offer higher initial deductions. Here's what you need to know:

• Full access to capital works deductions: You can claim the entire 40 years of deductions, starting from construction. 
• Higher plant and equipment deductions: As the owner of a brand-new investment property, you can claim the depreciation on all eligible plant and equipment items at their full value. Property investors who purchased a second-hand residential investment property after 9 May 2017 are unable to claim depreciation on existing plant and equipment assets. They can only claim tax depreciation for plant and equipment that they’ve purchased. This means those purchasing old or second-hand properties may miss out on plant and equipment deductions.

Visit the Australian Tax Office’s (ATO) website for information on what you can claim, opens in new window.

Depreciation methods

This refers to how you calculate the yearly decline of the value of your property’s assets. The two approved methods by the ATO are:

Prime cost method

This method relies on spreading the depreciation evenly over the asset’s effective life, giving you a steady tax deduction each year. This helps you plan your cash flow and can be ideal for long-term property investors. Here’s how this depreciation method works with an example:

Let’s say you purchase a dishwasher worth $1400 with an effective life of 10 years. Using the prime cost method, you’ll be able to claim:

$1400 divided by 10, which equates to $140 per year.

Diminishing value method

With this method, you can claim higher amounts and accelerate depreciation in the early years of the asset’s life. Typically, it’s calculated as a percentage of the asset’s remaining value and so, it decreases every year.

The formula to calculate depreciation using the diminishing value method is:

Base value x (days held ÷ 365) x (200% ÷ asset’s effective life)

Using the example of the dishwasher, in your first year you’ll be able to claim:

1400 x (365 ÷ 365) x (200% ÷ 10) = 1400 x 0.2 = $280

In the second year, your claims will be:

(1400-280) x (365 ÷ 365) x (200% ÷ 10) = 1120 x 0.2 = $224

The calculation will continue till the value of the asset reaches zero.

Practical steps to claim depreciation

To ensure you're making the most of depreciation, follow these steps:

• Determine eligibility by reviewing the ATO's guidelines for your property type.
• Engage a quantity surveyor to assess your property's construction value and prepare a detailed depreciation report.
• Collaborate with your accountant to incorporate the depreciation schedule into your annual tax return, optimising your tax position.

If you’re looking for tailored advice and support with your investment property build or purchase, our team is here to help.