How Depreciation Can Work

Some stories from the ‘burbs'

...or how property investors can make their investment property work even harder for them.

How does depreciation work? Here are some hypothetical scenarios.

Mr. and Mrs. Smith used the equity in their home to purchase an investment property. They borrowed the total purchase price of $300,000.00 to pay for the investment house at 7% interest only through their bank. The remaining mortgage debt on their principal place of residence is also $300,000.00, which they are paying off at principal & interest.

The tax refundable difference for Mr. Smith, who is on a gross income of $55,000 per annum, is $1260 and the difference for Mrs. Smith – who is on $42,000 is also $1260. Therefore the additional cash flow for Mr & Mrs Smith due to the depreciation deduction will be $48.50 per week or $2,520 per year.

The benefits of their tax depreciation really start to kick in over time: In five years, their Loan balance - with minimum repayments – is $282,400. Or – with an extra $97 per fortnight, the loan balance is reduced to $255,400, which represents a saving of $27,000.

Table 1. The Smiths

Additional cashflow due to depreciation deduction: Therefore, the additional cash flow for Mr and Mrs Smith due to the depreciation deduction will be $48.50 per week or $2,520 per year.

Let us now have a look at Ms. D. Duction’s situation. Ms. Duction is single, on a gross income of $62,000 per annum and wants to use property investment to increase her wealth portfolio. So she uses the equity in her own home to purchase an investment property. She borrows the total purchase price of $280,000 to pay for the investment house at 7% interest only. The remaining mortgage debt on her principal place of residence is also $290,000, which she is paying off at principal & interest. But what difference will a Tax Depreciation schedule make to this situation?

Ms Duction’s taxable income after claiming her rental’s loss is $51,170 but when you include her depreciation it is reduced to $46,170. Instead of expecting a cheque for $3,892 from the tax department she can now look forward to a cheque of $5,466!

The additional cash flow for Ms. Duction due to the depreciation deduction will be $30.20 per week or $1,574 per year.

Admittedly, this does not sound like much in the short-term, but let us observe the difference over 5 years. In five years, if she had only made only the minimum payments, the loan balance would be $264,530. However, using the difference created through her TD Schedule, with an additional $60 per fortnight, you can see that the loan balance is reduced to $242,750, representing a saving of $21,600. Not bad!

Table 2. Ms. D. Duction

Additional cashflow due to depreciation deduction:

Therefore, the additional cash flow for Ms D. Duction due to the depreciation deduction will be $30.20 per week or $1,575 per year.

It’s important to get a tax depreciation schedule done by a professional. You’re accountant, doesn’t have the time or the experience. They do enjoy it though, when you hand a professionally compiled document for them to work on when they do your tax.