Property depreciation and selling a rental property
People sell their rental properties for a variety of reasons. These might include to pay off debt; for retirement savings; the property is too difficult to manage; or, they are looking to invest in other options.
When selling a property, we need to consider the capital gains taxation (CGT) implications. Many people believe that CGT is just the difference between what they sell the property for and what they paid for it. This common misconception means that each year I have at least one client who comments to me when we are doing their tax:
‘I sold my investment property, but I only got back what I paid for the property so there won’t be any tax … will there?’.
Sadly, it’s not that simple! If they have been claiming depreciation on the property then we need to take this into account.
What is property depreciation?
Property depreciation is the wear and tear on a building and the items within it. The Australian Taxation Office (ATO) allows owners of income-producing properties to claim this depreciation as a deduction in their annual tax return, meaning they reduce their taxable income and pay less tax.
Property depreciation is made up of two main parts: capital works deductions (the building, bricks, walls, floors, roofs, windows, tiles, pergola, and electrical cabling); and plant & equipment (contents mechanical and easily removable assets contained in an investment property) depreciation.
Depreciation is typically calculated by a specialist (e.g. BMT) who inspects the property and prepares a report valuing the items and calculating the depreciation.
How property depreciation affects the tax value of the property
When you purchase a property the cost of the property and acquisition costs (like stamp duty, conveyancing and other purchase costs) add up to be what is the ‘cost base’ for capital gains tax purposes.
For taxation purposes if you claim depreciation on the property this, in effect, reduces the cost base of the property, even though it may be increasing in market value.
For instance:
|
Property Contract Price |
480,000 |
|
Stamp duty & other costs |
20,000 |
|
Total (Cost Base) |
500,000 |
|
Depreciation Claimed |
(10,000) |
|
Adjusted Cost Base |
490,000 |
Therefore, when calculating capital gains tax, on sale, the cost of the property is now $490,000 to reflect the depreciation claimed.
What happens when you sell the property?
Let’s assume that you purchase the property for $500,000 and own for 10 years claiming $10,000 of depreciation each year and that your taxation rate is 32.5% (your taxable income is $37,001–$90,000)
By claiming $10,000 as a taxation deduction each year you will save $3,250 in tax; over 10 years this is a tax saving of $32,500.
As you have claimed depreciation the adjusted cost base of the property is:
|
Property Price including Costs |
500,000 |
|
Depreciation (10 years x $10,000) |
(100,000) |
|
Adjusted Cost Base |
400,000 |
Taxation on sale
|
Sale Price |
500,000 |
450,000 |
|
Adjusted Costs base |
400,000 |
400,000 |
|
Capital Gain |
100,000 |
50,000 |
|
50% reduction1 |
(50,000) |
(25000) |
|
Taxable Capital Gain |
50,000 |
25,000 |
|
Taxation at 32.5% |
16,250 |
8,125 |
(1) A 50% exemption on CGT is available to individuals or small business owners who hold an investment property for more than 12 months from the signing date of the contract before selling the property.
The Taxation Effect
The above example shows that even if you sell the property for less than you originally paid for it that there may be capital gains tax to pay on the sale.
Whilst this can be disappointing there has been the taxation benefit enjoyed over the years. For example, if the property was sold for what you paid:
|
Tax benefit of depreciation $10,000 x 32.5% x 10 years |
32,500 |
|
Capital gains tax on sale |
(16,250) |
|
Net benefit |
16,250 |
You have also had the tax benefit of claiming the depreciation each year; so if this paid off the loan, for example, it would have saved you interest over time. You can see from this then, why I always recommend claiming depreciation!
Therefore, before selling a property, it is worth calculating the potential capital gains that may apply as:
- It may be beneficial to hold on until your taxable income is lower in order to reduce capital gains tax
- The current low interest rates mean that holding costs are also low – especially compared to the large capital gains tax on the sale
- You’ll avoid any nasty surprises!
If you’re considering selling your investment property – for whatever reason – speak to us first. We can help calculate your CGT and offer suggestions on how to reduce or minimise it and plan the most beneficial way forward.