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A Layman's Explanation of Depreciation

Many of our readers would be familiar with the way work tools and equipment and motor vehicles depreciate over time. They also understand certain occupations have items fundamental to that occupation. These people are allowed to claim tax deductions for the depreciation of their tools of work.

Well, property investors have the same opportunity. Let me explain give a layman’s explanation of depreciation for property investors.
Property depreciation falls into two broad categories, capital works and plant and equipment. Let’s start by looking at capital works depreciation.

CAPITAL DEPRECIATION

All buildings have ‘four walls, a roof and a floor’ – loosely speaking these are the primary items included when capital works depreciation is assessed.

Having said that capital works items also includes plumbing, cabling and fixtures such as baths, sinks etc. All of which are fabric to the building itself.
The ATO defines capital works depreciation as being, “building construction costs, the cost of altering a building and/or the cost of capital improvements to the surrounding property.”

Capital works depreciation is calculated at 2.5% of construction costs per year over a 40 year period from date of construction. If constructions costs are $200,000 then the capital works claim is $5,000 (being 2.5% X $200,000) per annum for 40 years.

PLANT & EQUIPMENT

Investment properties also have ‘removable bits’ – these items will generally speaking be classified as plant and equipment and be depreciated on the basis of their effective life. This is where it gets a little complex as different items have different effective lives – put simply if something is very durable then the effective life is longer than something less durable.

This category includes such things as window treatments, floor coverings and furniture. Claims are calculated using the purchase cost and effective life to determine annual claims.

Included in plant and equipment are items of less than $1000 in value. These items have an accelerated claim attached to them and can significantly increase claims in a tax year. The key with this group is that items which initially had a purchase price above $1000 may still be eligible to lumped into the low-asset pool when their residual value falls below the $1000 mark.