Depreciation – The key to negative gearing
If the cost of owning an investment property is more than the income you receive, what’s the point?
I mean sure, Negative Gearing allows you to offset those losses against your other income, but even on the highest tax scale of 45% you’re still losing 55% of your hard earned cash (at least on paper).
So, let’s talk depreciation.
A property with a large depreciation allowance allows you to have a positively geared cash flow yet be negatively geared for tax purposes.
Let me explain further.
The Australian Taxation Office regards depreciating assets as a long-term cost of ownership.
In most properties there are many items that will, over time, deteriorate – i.e. the value of those items will depreciate. The ATO has worked out what items you are allowed to claim as depreciation as a deduction over specified period of time. There are two main types of depreciation claims: those for capital works and those for depreciating assets.
- Capital works are improvements to the property that are of a structural nature and fixed to the property. For example, kitchen and bathroom renovations, paving and driveways, built-in cupboards, clothes lines and fences are regarded as capital items (but note that not all capital works are recognised and advice should be taken here). Capital works include the initial cost of building, but not the cost of the land. When buying into any brand new building, you are entitled to claim all or a portion of the construction costs.
- Equipment and appliances are depreciating assets and include such items as kitchen appliances, carpets and other floor coverings, window finishes, air-conditioning units, alarms and pool equipment.
When you buy a brand new property, a list of these costs, known as a depreciation schedule, should be available from the property developer; this identifies the cost of every item that can be claimed. On older properties, there may still be items that you can claim depreciation on.
You can commission a quantity surveyor who specialises in preparing depreciation schedules to draw up a schedule for you.
A claim for depreciation is treated as an expense and is included as a cost of ownership that is deducted from the rental income. Negative gearing legislation allows any loss made on an investment property to be applied against other income.
If depreciation is the cause of the loss, then it seems you can have your cake and eat it too.
For a better understanding of negative gearing see our previous blog “What’s This Thing Called Negative Gearing?”
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