Depreciation. Why a 2010 build still has $40,000 of deductions left.

Depreciation is one of the most under-claimed tax deductions in Australian residential property investment. The ATO data suggests roughly 60-70% of investment properties claim some depreciation. Of those that do, many claim less than they could because they have not commissioned a proper depreciation schedule.

For a typical investment property, properly modelled depreciation can reduce taxable income by $5,000-15,000 per year. At a 37% marginal tax rate, that is $1,850-5,550 of tax saving annually.

This post explains what depreciation is, how the schedule works, and why a 2010 build still has substantial deductions left.

What depreciation is

Depreciation is the recognition of the decline in value of capital items over time. The Australian Tax Office (ATO) allows two categories of depreciation deductions on residential investment property:

Capital works (Division 43)

The structure of the building itself: walls, floors, ceilings, roof, structural elements, plumbing, electrical, fixed fixtures.

• Eligible: any residential property built after 17 July 1985
• Rate: 2.5% per year (for a 40-year effective life)
• Total deductible: 100% of the construction cost over 40 years

Plant and equipment (Division 40)

Loose items not structurally attached: appliances, carpets, blinds, light fittings, hot water systems, air conditioners, ovens, dishwashers, ceiling fans, garage door openers.

• Eligible: items installed by the current owner (post-2017 rule changes excluded "previously used" items for residential second-hand purchases)
• Rate: varies by item, typically over 4-15 year effective life
• Total deductible: 100% of the item cost over its effective life

Why a 2010 build still has $40,000 left

A residential dwelling built in 2010 with a construction cost of $300,000 generates:

• Capital works deduction: $300,000 × 2.5% = $7,500 per year
• Eligible period: 40 years from build, so 2010 to 2050
• In 2026 (16 years in): 24 years remaining
• Remaining deductible: $7,500 × 24 years = $180,000

If the property changed hands at any point, the remaining capital works deduction transfers to the new owner. A 2024 buyer of the 2010-built property inherits the remaining 24 years of $7,500 per year deductions. Total: $180,000 to claim over the next 24 years.

For a 37% bracket investor, that is $66,600 of tax saving over the property's remaining depreciation life.

The 2017 change that complicates things

In May 2017, the federal government changed the rules for "previously used" plant and equipment in second-hand residential property purchases:

Pre-May 2017

Buyers of second-hand residential property could claim depreciation on the plant and equipment installed by previous owners. The depreciation schedule allocated value to existing carpets, blinds, appliances, etc.

Post-May 2017

Buyers of second-hand residential property can NOT claim depreciation on previously used plant and equipment. Only items the current owner installs (new appliances, new carpets, etc.) are eligible.

The capital works deduction (Division 43) is NOT affected. The structural deduction continues to apply.

The practical implication: for second-hand property purchases since May 2017, the depreciation schedule's plant and equipment component is reduced. The schedule may still show $5,000-15,000 per year of deductions, but more of that comes from capital works than from plant.

How to claim depreciation

Three steps:

Step 1: commission a depreciation schedule

A quantity surveyor (QS) visits the property, documents all the capital works and plant items, and prepares a schedule that allocates the construction cost to each component with the appropriate effective life and depreciation rate.

Cost: $700-1,500 for a typical residential property. The cost is itself fully tax-deductible.

The QS should be registered with the Australian Institute of Quantity Surveyors (AIQS). Some specialise in residential depreciation schedules (BMT, Washington Brown, etc.).

Step 2: include in your tax return

Your accountant uses the schedule to populate the depreciation section of your investment income return (Schedule 2 of the rental property worksheet). The deductions flow through to your taxable income.

Step 3: claim each year

The schedule is valid for the life of the property. You claim the year's allocated deductions each tax return. No need to re-commission the schedule unless you significantly renovate (in which case the new capital works are added).

What if you have not claimed depreciation in previous years?

Two options:

Option 1: amend prior returns

The ATO allows amendments to tax returns up to 2 years after assessment for most individual taxpayers. You can amend the past 2 years' returns to include the depreciation deductions retrospectively, generating a tax refund.

Option 2: start claiming this year

You can start claiming this year and continue forward. You forgo the past years' deductions but capture all future deductions.

Most investors who realise they have not been claiming go for Option 1 if the past 2 years had substantial deductions ($10,000+ per year), and Option 2 if the amount is smaller.

When depreciation is most valuable

Three scenarios:

Scenario 1: newer properties

Properties built within the last 10-15 years have higher annual capital works deductions because the construction cost is more recent and (usually) higher in real terms. They also have more years of depreciation life remaining.

Scenario 2: high marginal tax investors

The value of any tax deduction scales with your marginal rate. A 19% bracket investor saves $190 per $1,000 of deduction. A 47% bracket investor saves $470. The same deduction is 2.5x more valuable to the high-income investor.

Scenario 3: first investment property purchases

Many first-time investors do not commission a depreciation schedule because the cost feels avoidable. The cost-to-benefit ratio is usually overwhelmingly in favour of doing it. $700 in vs $30,000-60,000 of additional deductions over the property's holding period.

When depreciation is less valuable

Three scenarios:

Scenario 1: very old properties

Pre-1985 properties have no capital works deduction (the eligibility cut-off). Only post-1985 substantial renovations to old properties create new capital works deductions.

Scenario 2: properties owned by self-managed super funds

SMSFs have a lower marginal tax rate (15% accumulation phase, 0% pension phase). The tax saving from depreciation is smaller in SMSF context.

Scenario 3: positively geared investments

A positively geared investment generates taxable income on its own. Depreciation reduces that taxable income but does not unlock additional tax recovery beyond it. The benefit is still real but smaller than for a negatively geared property.

Depreciation is one of the most consistent revenue streams available to Australian property investors. The deductions are non-cash. The schedule cost is small. The ongoing tax saving is substantial. For any negatively geared investment property, commissioning a depreciation schedule in the first year is one of the highest-return administrative decisions you can make.