Depreciation refers to the reduction in value that occurs as items age and wear out. This is particularly relevant for investment properties, where items are classified as either Plant and Equipment or Capital Works. Tax depreciation is the term used to describe the reduction in value of these items or the building itself, which can be claimed as a tax deduction by investors to increase their tax refunds.

To determine your depreciation deduction, the general depreciation rules are typically used, unless your asset qualifies for the instant asset-write off or simplified depreciation rules for small businesses. There are two methods prescribed by the ATO to calculate the depreciation claim, namely the prime cost method and the diminishing value method, which can be applied to both Plant and Equipment and Capital Works items in your investment property.

Based on recent Government changes, an individual investor who acquires a residential rental property after 7.30pm AEST on 9 May 2017 from a previous owner (‘second-hand property’) will not be entitled to claim Division 40 depreciation from 1 July 2017 for existing depreciable assets in that property.

Instead, a capital loss (equal to the difference between an asset’s original cost/value and its termination value) may be available (to be offset against capital gains) when such assets are eventually disposed of (e.g., scrapped or sold as part of the sale of the property) for less than their original cost.

However, any qualifying (i.e., new) depreciable assets acquired for a second-hand property can be depreciated as normal to the extent they are used for income-earning purposes.

Investors who acquire new residential properties will generally not be affected by the recent changes and, therefore, will generally be able to claim depreciation deductions for assets within such a property (to the extent such assets are used for income-earning purposes).

Where an individual investor acquired a second-hand residential rental property before 7.30pm on 9 May 2017, the investor can generally continue to claim depreciation for existing depreciable assets in that property. However, second-hand residential properties acquired before this date, but not used for income-earning purposes at all during the 2017 income year (e.g., they were used solely for private purposes) will be affected by the changes if the property becomes income-producing from 1 July 2017.

Furthermore, the recent Government changes do not restrict the ability of an investor to claim Division 43 building write-off deductions (where applicable) for a residential rental property acquired after 7.30pm on 9 May 2017. Depreciation claims in respect of commercial properties and properties used in the course of carrying on a business will also not be affected by the recent depreciation changes.

In light of the recent changes, where a Rental Property Depreciation Report is ordered from 1 July 2017 (particularly for a residential property acquired after 7.30pm on 9 May 2017), it is important the depreciation report provider closely review the order to determine and advise whether a report is appropriate for that property.

In summary, the changes affect:

• Second-hand residential properties purchased after 7:30pm on 9 May 2017, and depreciation deductions for assets in existence at the date of purchase only.
• Residential properties purchased before 7.30pm on 9 May 2017 and not used for income-earning purposes at all during the 2017 income year.

The changes do not affect:

• New residential rental properties.
• Residential properties used in the course of carrying on a business.
• Division 40 depreciation claims for new assets (e.g., furniture, chattels, etc.) subsequently purchased (for any residential rental property) by the current owner of the property.
• Division 43 building write-off deductions.
• Commercial properties.

Capital Works are comprised of the components that form the building itself, including any fixtures that are attached to it. Also known as: Division 43 (ATO Term) | Building Write-Off | Capital Works Allowance.

Here are some items you could depreciate part of the building:

There are 2 questions we always ask an investor to answer:

1. When was your building built?
2. What type of building do you own or lease?

Using these two key pieces of information, we can deduce approximately how much your brand new or second hand property can claim on construction costs.

Refer to this guide to check whether your property qualifies for Capital Works (based on construction commencement year):

Plant and Equipment assets are typically those that can be easily removed from the property and tend to have a shorter lifespan. This category often includes motorized items.

The rates of tax depreciation for Plant and Equipment assets vary for commercial and residential properties and are determined by the ATO's Asset Effective Life Schedule. This schedule provides guidance on the expected lifespan of an asset, which is used to calculate the rate of depreciation for tax purposes.

Plant and Equipment assets provide an accelerated level of property depreciation because they tend to wear out more quickly than the building itself. This allows investors to claim a greater amount of tax depreciation in the earlier years, typically within the first five years of ownership.

To facilitate this process, the ATO permits quantity surveyors to assess the value of these assets and include them in the tax depreciation schedule.

Investors who purchase a second-hand residential property after 7:30pm on May 9th, 2017 and sign the contract are not qualified to claim property depreciation on plant and equipment (division 40). However, they can still claim tax depreciation on newly acquired plant and equipment, such as carpet and air-conditioning units.

The following scenarios qualify for tax depreciation:

• Brand new residential properties
• Buildings that still qualify for building depreciation (see division 43)
• Second-hand properties that have had substantial renovations
• Second-hand properties that have had minor renovations
• Investors that purchase property in Managed Funds
• Corporate entities that buy properties (e.g. Pty Ltd Company)
• Second-hand properties owners who purchase new plant and equipment
• Owners who switch from Principal Place of Residence (PPOR) to rental properties prior to 1^st July 2017
• You own a property that is not residential (commercial, manufacturing or motels)