What Are Depreciating Assets in a Rental Property?
Depreciation is one of the most valuable tax deductions available to property investors in Australia. It allows you to claim deductions for the decline in value of assets within a rental property over time, reducing your taxable rental income without requiring any out-of-pocket expense in the year of the claim. Despite its significance, depreciation is one of the most commonly overlooked or incorrectly claimed deductions among property investors.
At Trinity Accounting Practice, we help property investors across Sydney and Australia understand their depreciation entitlements and ensure their claims are accurate, compliant, and maximised.
Depreciating assets are items within a rental property that have a limited effective life and decline in value over time. These are generally removable or mechanical items, as distinct from the building structure itself. Common examples include appliances such as ovens, dishwashers, and air conditioners, as well as carpets and curtains, furniture, hot water systems, electrical fittings and security systems, floating floorboards and vinyl flooring, ceiling fans, blinds, and smoke alarms.
Each of these assets has an effective life determined by the ATO, which dictates the period over which the deduction can be claimed. Investors can choose to use the ATO's effective life determination or, in some cases, make their own reasonable estimate based on the circumstances of use.
How Depreciation Is Calculated
There are two methods for calculating depreciation deductions on rental property assets, and the method you choose affects the size and timing of your deductions.
Prime Cost Method
Under the prime cost method, deductions are spread evenly over the asset's effective life. This means you claim the same amount each year until the asset is fully depreciated. For example, if you purchase a $5,000 air conditioning unit with an effective life of 10 years, you would claim $500 per year for 10 years.
The formula is: asset cost multiplied by (days held divided by 365) multiplied by (100% divided by effective life in years).
Diminishing Value Method
Under the diminishing value method, higher deductions are claimed in the earlier years of the asset's life, with the amount decreasing each year as the remaining value reduces. This method is beneficial if you want to maximise your deductions in the first few years after purchasing or installing the asset.
The formula is: base value (the remaining value of the asset) multiplied by (days held divided by 365) multiplied by (200% divided by effective life in years).
Once you choose a method for a particular asset, you must continue using that method for the life of the asset. However, you can use different methods for different assets within the same property. Your choice of method should be guided by your overall tax planning strategy and whether you benefit more from larger upfront deductions or a steady, even claim over time.
The Second-Hand Asset Restriction
Since 9 May 2017, property investors who purchase a previously used (second-hand) residential rental property can no longer claim depreciation deductions on existing depreciating assets that were already in the property at the time of purchase. This restriction applies to assets such as carpets, blinds, appliances, and hot water systems that were installed by a previous owner.
However, you can still claim depreciation on brand new assets that you purchase and install yourself after settlement, as well as on assets in a newly constructed property where you are the first owner. If you purchase a property and then replace an existing air conditioner with a new one, the new unit is fully depreciable under either method.
It is important to note that the second-hand restriction applies only to residential rental properties. It does not apply to commercial rental properties, and it does not apply to corporate tax entities, superannuation funds (including SMSFs), or public unit trusts that hold residential property. If you hold residential investment property through an SMSF, you may still be entitled to claim depreciation on second-hand assets — but the rules are complex and professional advice is essential.
Capital Works Deductions — Division 43
Capital works deductions are separate from depreciating asset claims and apply to the construction costs of the building itself. These include the structural elements of the property such as walls, roofing, doors, built-in cabinetry, kitchen and bathroom fixtures that are permanently affixed, driveways, fences, and retaining walls.
Capital works deductions are claimed at 2.5% per year over 40 years from the date construction was completed. This means a property with $300,000 in eligible construction costs would generate $7,500 per year in capital works deductions for 40 years. Unlike depreciating assets, there is only one method for claiming capital works — the 2.5% straight-line rate.
To claim capital works deductions, the property must have been constructed after 15 September 1987 for residential properties, or after 20 July 1982 for certain non-residential buildings. If the construction date or original cost is unknown, a qualified quantity surveyor can prepare an estimate based on an inspection of the property.
The second-hand asset restriction that applies to depreciating assets does not apply to capital works deductions. Even if you purchase an older property, you can still claim capital works deductions on the remaining unclaimed portion of the original construction costs, provided the property was built after the relevant date.
The Importance of a Tax Depreciation Schedule
A tax depreciation schedule is a report prepared by a qualified quantity surveyor that identifies and values all depreciating assets and capital works items within a rental property. The schedule sets out the deductions available under both the prime cost and diminishing value methods for each asset, as well as the annual capital works deduction.
Engaging a quantity surveyor to prepare a depreciation schedule is one of the highest-return investments a property owner can make. The cost of the schedule is itself tax deductible, and the deductions identified typically far exceed the cost of preparation. For a typical residential investment property, depreciation deductions (combining both depreciating assets and capital works) can amount to several thousand dollars per year in the early years of ownership.
It is worth noting that the quantity surveyor does not need to inspect the property in every case. For newer properties, a desktop assessment based on construction plans and specifications may be sufficient. For older properties, an on-site inspection is usually required to identify eligible items.
Record-Keeping Requirements
You must keep records of all asset purchases and installation dates for the entire period of ownership plus five years after you lodge the tax return that includes the final depreciation claim or the capital gains tax event (such as the sale of the property). This includes purchase receipts, invoices for new assets installed, and the depreciation schedule itself.
If you dispose of or replace a depreciating asset during the income year, you may need to make a balancing adjustment. This could result in either an additional deduction (if the asset was scrapped or sold for less than its written-down value) or assessable income (if the asset was sold for more than its written-down value). Keeping accurate records of asset disposals is essential for calculating these adjustments correctly.
Our bookkeeping team can help you maintain a comprehensive record-keeping system for your investment property, ensuring all depreciation-related documents are organised and accessible at tax time.
Common Mistakes Property Investors Make
The most common depreciation mistakes we see include failing to obtain a depreciation schedule at all, confusing capital works deductions with depreciating asset claims, claiming depreciation on second-hand assets in properties purchased after 9 May 2017, not adjusting depreciation claims when assets are replaced or disposed of, and failing to apportion deductions when a property is only available for rent for part of the year.
If your rental property was vacant for a period, under renovation, or used for private purposes during part of the income year, your depreciation deductions must be reduced proportionally. Only the period during which the property was genuinely available for rent qualifies for a deduction.
For property investors with multiple properties across different real estate portfolios, our tax and accounting team can coordinate your depreciation claims across all properties to ensure every entitlement is captured.
Trinity Accounting Practice
Accounting Firm in Beverly Hills, Sydney
Phone: 02 9543 6804
Address: 159 Stoney Creek Road, Beverly Hills NSW 2209
Website: www.trinitygroup.com.au
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