Buildings and the things inside them wear out over time. Tax rules recognise this by letting property investors claim a portion of that decline in value each year as a deduction against their rental income. That deduction is depreciation.
What makes it unusual — and valuable — is that it is a non-cash deduction. Unlike rates or interest, you don't write a cheque for depreciation. The wear happens on its own, yet you still get to reduce your taxable income by it. For many investors it is the difference between a property being negatively geared on paper and positive in the bank.
The two types of depreciation
A depreciation claim is made up of two distinct categories, and they behave very differently.
Capital works
The building structure itself
The bricks, concrete, roof and permanent fixtures. Capital works are typically deductible at a steady 2.5% a year over 40 years. It's the larger, more predictable half of most depreciation claims — and it applies to the structure regardless of who installed it.
Plant and equipment
The removable assets inside
Carpets, blinds, ovens, air conditioners, hot water systems and the like. These items wear out faster, so they depreciate more quickly and on individual schedules. Rules on second-hand items vary, which is why a professional schedule matters.
Why a non-cash deduction is so useful
Every other deduction on a rental property represents money that actually left your account. Depreciation doesn't. It reflects an accounting recognition of wear, so it lowers your taxable income and therefore your tax bill without touching your cash flow.
The practical effect is to lift your after-tax return. A property that looks break-even before tax can turn cash-flow positive once a depreciation claim reduces the tax owed on its income — which is exactly why investors commission a depreciation schedule from a quantity surveyor.
A worked example
Suppose a property generates a combined depreciation deduction of $9,000 in a year — say $6,500 of capital works plus $2,500 of plant and equipment. If your marginal tax rate is 37%, that deduction reduces your tax by roughly $3,330.
You didn't spend $9,000 to earn that benefit — the deduction simply recognises the building and fittings ageing. That $3,330stays in your pocket and materially improves the property's after-tax cash position.
Things to keep in mind
- It affects your cost base — depreciation claimed on capital works generally reduces the property's cost base, which can increase the capital gain calculated when you eventually sell.
- A schedule pays for itself — a quantity surveyor's depreciation schedule is itself deductible and usually unlocks far more in deductions than it costs.
- Rules change over time — the treatment of second-hand plant and equipment in particular has shifted, so what a previous owner could claim may differ from what you can.
- It's a tax matter — depreciation interacts with your wider tax position, so confirm the specifics with a qualified tax adviser.
Estimate a depreciation claim
Use our free depreciation calculator to get a sense of the annual deduction a property might support.
Open the depreciation calculator