A depreciation schedule is a great tool for property investors as it is considered a “non-cash deduction”. Unlike other property expenses that you need to pay out of your own pocket first, a depreciation schedule is paid for once, but it can be reused year after year to claim back legitimate tax deductions.
The following article is written to help you to understand the general concept of depreciation on an investment property. Investors should always consult their accountant when making financial decisions that will impact their investment property.
What Difference can Depreciation Have on a Rental Properties?
Depreciation isn't hard to understand, but it can be confusing for new property investors. The best way to understand property depreciation is to consider the positive benefits it has on your cash flow. The following hypothetical scenarios can help you to understand how much you can claim back if you have a deprecation schedule, and what happens if you don't.
Mr Robert Projeski, the Managing Director of Australian Mortgage Options (AMO), recommends that investors speak with their accountants about lodging a PAYG Withholding Variation Form with the ATO. Not only will this significantly reduce their tax bill, but it “could significantly improve an investor’s cash flow and leave more money in their pockets.”
Example Scenario
To understand how depreciation works, we will use two scenarios – the first scenario shows what happens if no depreciation was claimed, and the second shows how claiming depreciation can positively impact your cash flow.
Consider an investor who buys a two bedroom unit for $400,000 that is only a few years old. The rent on this property is $400 per week or $20,800 per year. During the financial year the investor incurs running expenses totalling $30,000 (interest repayments, management fees, maintenance costs etc). As long as the property is rented out and producing an income, you can legitimately claim these expenses through your income tax.
Scenario 1: How much would it cost if no depreciation was claimed?
In our first scenario, the total pre-tax loss is $9,200 ($30,000 expenses - $20,800 rental income). This equates to a loss of $177 per week. However, because this is a rental property, the ATO will allow you to write off these losses.
Using a hypothetical tax rate of 39 per cent (which includes the Medicare levy), the total tax refund will be $3,588. The cash outlay will be $5,612 per year, or $108 per week.
Scenario 2: How much would it cost if depreciation was claimed?
In our second scenario, we have a depreciation schedule prepared for our investment property. Because this is a newly built unit, the investor can expect to claim more in depreciation than with older properties.
Let’s say the depreciation for this unit is $12,000, this brings our total pre-tax deduction to $21,200 ($12,000+$9,200). At the tax rate of 39 per cent, the investor can therefore claim a total refund of $8,268 ($21,200 less 39%). The total cash outlay for the year is $932 ($9,200 expenses - $8,268 refund) or $18 per week.
Thus the difference of having a tax depreciation schedule and not having one is a staggering $90 per week.
Is there any Benefit to having a Depreciation Schedule Done for an Older Property?
Mr Robert Projeski says that there is a common misconception when it comes to claiming depreciation on older properties. People often think that only newer properties benefit from depreciation, when in fact an older property can also have significant depreciation benefits.
According to the Australian Tax Office, you are entitled to claim capital works deductions if the rental property was built after 17 July 1985. Some properties that are older than this legislated date may have had renovations done to it, as a result a quantity surveyor may be able to uncover significant deductions.
The other good news is that deductions on plant and equipment items are not dependent on a fixed date. This means that you can claim deductions based on the effective life of such items as set by the Australian Taxation Office.
Property depreciation claims have the potential to improve an investor’s cash flow, and in some situations even turn a negative cash flow property into a positive one.