Tax deductions that can be claimed for depreciation on investment properties can be worth thousands.
Say an investor had bought a newly constructed apartment for $460,000 at the start of this financial year. Assuming the property was tenanted for the full year, the investor could claim $11,500 as a building allowance deduction in his or her tax return (based on 2.5 per cent of the purchase cost, depreciated in a straight line over 40 years from the building's completion).
On top of that, the investor could claim for plant and equipment items, such as carpets, dishwashers and freestanding furniture.
The tax payer can choose one of two methods to calculate the deduction that can be claimed for depreciation on the item:
Straight line: Under one method, a deduction can be claimed based on a straight line calculation of the item's decline in value over each year of its forecast life.
If the unit's carpets cost $6000 and are expected to last 10 years, the investor could claim a $600 deduction each year for 10 years (10 per cent of the original cost).
Diminishing value: The second type of depreciation, the diminishing value method, uses a rate that is double that of the prime cost method.
Using the $6000 carpet in the example above, the first year's deduction would be worth $1200, which is 20 per cent of its starting value. However, in the following year, the deduction is calculated based on the item's residual value after the deduction. In this case, $4800.
The deduction available in year two is then 20 per cent, of that amount, $960. And in year three, it's $768 (20 per cent of the remaining $3840).
How to choose
The method of depreciation that works best for the investor will depend on their circumstances.
Claiming a larger amount upfront may sound most appealing but from the fifth year on, the deduction will be larger using the prime value calculation method.
If the investor is making a loss for the first few years, but expects to have a higher taxable income in future years, it might be better to use the prime cost method, claiming a smaller amount in earlier years to benefit from a larger tax deduction in future.