Unless your investment property is made of diamonds, the home will experience general wear and tear.

Having tenants live in your rental property may contribute to it losing value over time. The good news for investors is that the Australian Taxation Office (ATO) recognises this and allows rental property owners to claim depreciation, but there are some rules to follow.

What is depreciation?

Depreciation is a blanket term the ATO uses to describe the fall in value of an asset over time as a result of general use.

Basically, as your investment property gets older, it may diminish in value as elements of the property (e.g. floors, carpets, built-in appliances, etc.) wear out, but these losses can be claimed against your taxable income.

Depreciation can be claimed by any property owner who earns income from a property. (Conversely, you can’t claim depreciation on your residential home, as you don’t get income from it.)

The ATO considers depreciation a 'non-cash deduction', meaning you don’t need to spend money to claim it. That’s because, for tax purposes, when you buy an investment property, you’ve essentially also bought the depreciating assets that come with it.

What can you claim on depreciation?

Items claimable for depreciation fall into two categories:

  • capital works
  • plant and equipment

Capital works

This refers to items that make up the structure of the building itself and which are subject to wear and tear.

Examples include:

  • the roof 

  • walls

  • driveways

  • bricks or other building materials

(However, things you can’t claim include land, landscaping, and the demolition of a previous home.)

Plant and equipment

This refers to items that don’t form part of a property’s structure, such as a dishwasher or other fittings. The ATO considers depreciating assets as generally:

  • separately identifiable
  • unlikely to be permanent
  • replaced within a relatively short period

Other examples of plant and equipment include:

  • carpets or other flooring

  • curtains

  • ovens

  • air conditioners

  • furniture

Depreciating items costing less than $300 can be claimed in full, immediately, in the income year you purchased them for a taxable purpose.

However, you can’t do this if the asset is part of a set which, together, exceeds $300. So, for example, if you buy four chairs for $250 each, you can’t claim each of them as separate assets.

How to calculate depreciation

There are two ways to calculate depreciation:

  • the prime cost method
  • the diminishing value method

You can choose whichever method will net you a higher depreciation rate and is most appropriate for your circumstance. Let's run through them.

Prime cost method

The prime cost, or straight-line, method assumes the value of an asset decreases uniformly over its effective life.

The ATO decides on the effective life of an asset each year and you can find a full list on its website. For example, according to the list, carpet has an effective life of eight years.

The prime cost method allows you to claim a fixed amount each year based on the following formula:

Asset’s cost × (days held ÷ 365) × (100% ÷ asset’s effective life)

So if you bought new carpet on the first income day of the year for $10,000, you could claim $1,250 in depreciation each year for its effective life of eight years, as seen in the formula below.

$10,000 x (365 ÷ 365) × (100% ÷ 8) = $1,250

Diminishing value method

The diminishing value method assumes the value of a depreciating asset decreases more in the early years of its effective life.

The following formula is used for the diminishing value method:

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

The base value includes the purchase cost, as well as any additional amounts you paid for transport or installation. It also decreases each year by the decline in the value of the asset.

Using the same example as above, you could claim $2,500 in depreciation in the first year of the carpet’s effective life of eight years, as seen in the formula below.

$10,000 x (365 ÷ 365) × (200% ÷ 8) = $2,500

For the second year, with the first year's depreciation subtracted, you could claim $1,875 as seen in the formula below.

$7,500 x (365 ÷ 365) × (200% ÷ 8) = $1,875

This continues until the balance reaches zero.

Do I have to calculate depreciation myself?

If you're nervous about having to calculate depreciation yourself, don’t stress. You can, but you can also seek the services of a qualified quantity surveyor who will do this for you.

It’s important to note accountants, real estate agents, valuers, or solicitors are not allowed to calculate your depreciation. The ATO stipulates quantity surveyors, who are also registered tax agents, are the experts qualified to assign values and estimate depreciation costs.

When you hire a quantity surveyor, they’ll put together something called a depreciation schedule.

This outlines all the deductions available on your investment property, which an accountant will use to prepare your tax return.

It’s recommended you engage a quantity surveyor as soon as possible after the settlement date, so they can inspect the property and see it as you purchased it.

A depreciation schedule is typically valid for the building’s lifetime, or as long as you own it. You can also backdate them by up to two years.

They can cost from around $300 up to $770 and generally take two to three weeks to prepare. (This cost is also fully tax deductible.) 

Depreciation of new properties

By their very nature, new properties offer substantial depreciation perks. In simple terms, here's how it works:

  • Full capital works deductions - you can claim a capital works deduction for the cost of construction for 40 years from the date the construction was completed
  • Higher plant and equipment deductions - owners of brand new investment properties can claim depreciation on all eligible plant and equipment items at their full value

Depreciation on old properties

An older property is likely to afford you fewer depreciation deductibles, but that doesn’t mean it’s not worth doing.

If your property was built prior to July 1985, you can only claim depreciation on plant and equipment.

The rules were further tightened for existing properties bought after 10 May 2017 which prevented investors from claiming depreciation on plant and equipment assets that had been previously used. In effect, it means you can only claim depreciation for items you've purchased yourself. 

However, depreciation for capital works assets can still be claimed in full.

Can I claim depreciation on renovations?

You can claim depreciation on renovations, provided the new assets are brand new.

If not, the ATO will consider them previously used and you won't be able to claim them.

In any case, it’s worth getting a depreciation schedule completed before and after renos, especially if they’re major. This is regardless of whether you had an existing depreciation schedule.

Having one done prior to major works means you can claim the remaining value of the outgoing items as a deduction, and having one done after means you can quantify the depreciation of the newly installed items.

Savings.com.au’s two cents

Depreciation offers property investors considerable benefits and can shave a significant sum off of your taxable income.

What you can and can’t claim can be a little complex - as are the calculations - so it’s worth engaging a quantity surveyor to ensure you’re getting the most deductions available to you.

If in doubt, the ATO provides some guidelines. Otherwise, consult a tax professional to ensure you're not missing out on the full benefit of owning an investment property.