depreciation construction

Depreciation on construction costs is treated differently to either items, it also has important ramifications for future capital gains tax.

Generally, a quantity surveyor is paid to develop a depreciation schedule, detailing the rental property deductions available for depreciation of the construction costs of a rental property. The quantity surveyor fees vary between $200 and $600 depending on how far the property is from a metropolitan area.

Whilst the building itself must be depreciated over a period of 25 years, many other items may be depreciated over a far shorter period. The rental property deduction available for depreciation on a newly constructed property is considerable, commonly between $7,000 and $10,000 per annum. After five to ten years, this rental property deduction may have reduced to $4,000 to $6,000 which is still enough to provide a considerable tax advantage.

Claiming a rental property deduction for depreciation of construction cost has a complex interaction with capital gains tax. Capital gains tax is tax payable on the profit you may make when selling a property. In short, you pay tax on the proceeds from the property, less any costs you have incurred in owning that property. Obviously one of the largest costs will be purchasing the property and constructing the building. However, at the point the capital gain tax event occurs (the sale of the property), if you have already claimed a rental property deduction for some of the construction cost, through depreciation, you cannot claim that amount a second time, against the proceeds of the sale. That said, because of the method by which the amount of capital gains tax is calculated, there is still an advantage (both in the short term, and in the long term) to claiming this depreciation as a rental property deduction.

To illustrate this example, lets suppose “John” has just purchased a newly constructed property for $500,000. He plans to sell the property in 5 years and estimates it will then be worth around $700,000. The property will be purchased solely in John's name, and his taxable income over the 5 year period will remain constant at $100,000 (after claiming rental property deductions). The quantity surveyors report shows that should he choose to, John can claim $50,000 in depreciation during the next 5 years.

If John chose not to claim any depreciation whilst owning the property, his capital gain at the time of sale would be $200,000 (the $700,000 sale price less the $500,000 purchase price). Bearing in mind his other income of $100,000 – the capital gain tax payable would be $40,900.

If however, John chose to claim depreciation whilst he is renting the property, his capital gain at the time of sale would be $250,000 (the $700,000 sale price less the $450,000 remaining purchase price). The capital gains tax payable on that amount, considering John's other income, is $52,525. That's $11,625 more than what he would have paid had he not claimed the depreciation on construction as a rental property deduction. However the tax reduction John has received in the interim, having claimed a deduction for the depreciation would be $20,000.

That's a tax saving of $8,375 over the five year period.