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How to Use Rental Property Depreciation to Boost Your Australian Home Loan Borrowing Power

How to Use Rental Property Depreciation to Boost Your Australian Home Loan Borrowing Power

Investing in rental property is a cornerstone of wealth creation for many Australians. However, the high cost of property means that securing finance is often the biggest hurdle. Lenders assess your ability to service a loan based on your income, expenses, and existing debts. For property investors, one of the most powerful yet underutilized tools to increase borrowing power is rental property depreciation. By understanding how depreciation works and how it can be leveraged in your loan application, you can significantly boost your declared income and improve your loan serviceability.

This article explains the mechanics of rental property depreciation, how it impacts your taxable income, and how you can use a depreciation schedule to enhance your borrowing capacity. We’ll also cover the relevant Australian Taxation Office (ATO) rules, lender policies, and practical steps to maximize your benefits.

What Is Rental Property Depreciation?

Depreciation is the natural wear and tear of a property and its assets over time. The Australian Taxation Office allows property investors to claim this decline in value as a tax deduction, reducing their taxable income. Depreciation can be claimed on two main components:

  1. Capital Works Deductions (Division 43): This covers the building’s structure and fixed items, such as walls, roofs, floors, doors, and windows. For residential properties built after 15 September 1987, you can generally claim 2.5% per year for 40 years. For properties with construction commenced before this date, capital works deductions may not be available unless renovations have been undertaken.

  2. Plant and Equipment (Division 40): This includes easily removable assets like carpets, blinds, air conditioners, ovens, and hot water systems. These items are depreciated based on their effective life, as determined by the ATO.

![Depreciation components of a rental property]( A surveyor with equipment conducts measurements on a construction site. Photo by Nelson Axigoth on Pexels )

How Depreciation Increases Cash Flow

Depreciation is a non-cash deduction—you don’t spend money to claim it. It reduces your taxable income, which means you pay less tax. This effectively increases your after-tax cash flow. For example, if you have $10,000 in depreciation deductions and your marginal tax rate is 37%, you save $3,700 in tax. This extra cash can be used to service a larger loan.

But beyond tax savings, depreciation can directly affect your borrowing power by increasing the income that lenders consider when assessing your loan application.

How Lenders Assess Borrowing Power

When you apply for a home loan or investment loan, lenders evaluate your ability to repay based on your net income minus expenses. They use a formula called the Net Serviceability Ratio (NSR) or Debt Servicing Ratio (DSR). The higher your net income, the more you can borrow.

Lenders typically look at:

  • Your gross employment or business income
  • Rental income from investment properties
  • Other income (e.g., dividends, family tax benefits)
  • Existing debts and living expenses

For investment properties, lenders usually assess rental income at a reduced rate (often 75-80% of gross rent) to account for vacancies, management fees, and maintenance. But they also consider the tax benefits of negative gearing and depreciation. Some lenders will add back depreciation deductions to your income when calculating serviceability, while others may not. Understanding this distinction is key to maximizing your borrowing power.

Depreciation Add-Back Policies

Many Australian lenders recognize that depreciation is a non-cash expense and will “add back” the depreciation amount to your net rental income. This effectively increases your assessable income. For example, if your rental property has a net rental loss of $5,000 after all expenses including $8,000 depreciation, a lender that adds back depreciation would treat your rental income as positive $3,000 ($5,000 loss + $8,000 depreciation = $3,000 positive cash flow). This can dramatically improve your serviceability.

However, not all lenders have the same policies. Some may only add back a portion, while others may not add back at all. It’s essential to work with a mortgage broker who understands which lenders are depreciation-friendly.

The Role of a Depreciation Schedule

A depreciation schedule is a comprehensive report prepared by a qualified quantity surveyor that outlines all the depreciation deductions available for your investment property. It is the document that lenders and the ATO rely on to verify your claims.

What a Depreciation Schedule Includes

  • Capital Works Schedule: Details the construction cost and yearly deduction for the building structure.
  • Plant and Equipment Schedule: Lists each depreciable asset, its value, effective life, and yearly deduction.
  • Total Deductions: Summarizes the total depreciation claimable for up to 40 years.

The schedule is valid for the life of the property and can be updated if you make renovations or add new assets.

How to Obtain a Depreciation Schedule

You need to engage a qualified quantity surveyor who is a member of the Australian Institute of Quantity Surveyors (AIQS) or the Royal Institution of Chartered Surveyors (RICS). The cost is typically between $400 and $700, and it is fully tax-deductible. The surveyor will inspect the property and prepare the report, which can be used for tax returns and loan applications.

![Quantity surveyor inspecting a property]( A surveyor with equipment conducts measurements on a construction site. Photo by Nelson Axigoth on Pexels )

Step-by-Step: Using Depreciation to Boost Borrowing Power

1. Get a Depreciation Schedule Early

If you’re planning to purchase an investment property or already own one, obtain a depreciation schedule as soon as possible. Even if you haven’t yet lodged a tax return claiming depreciation, you can provide the schedule to your lender to demonstrate future tax benefits.

2. Understand Your Lender’s Policy

Ask your lender or broker how they treat depreciation. Do they add back 100% of depreciation? Do they consider it in their serviceability calculator? Some lenders have specific policies for negative gearing benefits. For example, a lender might calculate your rental income as:

Gross rent × 80% + (Depreciation × marginal tax rate)

This approach recognizes that depreciation reduces tax, effectively increasing cash flow.

3. Include Depreciation in Your Loan Application

When submitting your loan application, provide the depreciation schedule along with your tax returns and rental statements. Highlight the depreciation amount and explain how it improves your net cash flow. If you haven’t claimed it before, you can still use the projected figures from the schedule.

4. Choose a Depreciation-Friendly Lender

Not all lenders are equal. Some of the major banks and non-bank lenders have more generous policies. Your mortgage broker can help you compare lenders and select one that maximizes your borrowing capacity. This is particularly important if you have multiple investment properties with significant depreciation claims.

5. Consider Future Depreciation Benefits

When buying a new investment property, consider the depreciation potential. Newer properties generally offer higher depreciation deductions, especially for plant and equipment. However, note that from 1 July 2017, the ATO restricted plant and equipment deductions to assets that were purchased new (not previously used) for residential investment properties. This means that if you buy an established property, you can only claim depreciation on plant and equipment if you installed it yourself or if it was purchased new by the previous owner after 9 May 2017 and you have the necessary evidence. Capital works deductions are still available for eligible properties.

Case Study: How Depreciation Increased Borrowing Power

Let’s look at a practical example. Sarah owns an investment property purchased for $500,000. The property was built in 2010, so she can claim both capital works and plant and equipment depreciation. Her depreciation schedule shows the following annual deductions:

YearCapital Works (Div 43)Plant & Equipment (Div 40)Total Depreciation
1$7,500$4,200$11,700
2$7,500$3,800$11,300
3$7,500$3,400$10,900
4$7,500$3,000$10,500
5$7,500$2,700$10,200

Sarah’s rental income is $25,000 per year. Her expenses (interest, rates, management, etc.) total $22,000, resulting in a net rental income of $3,000 before depreciation. After claiming $11,700 depreciation, her taxable rental loss is $8,700. At her marginal tax rate of 37%, she saves $3,219 in tax.

Now, when applying for a new loan, a lender that adds back depreciation will assess her rental income as:

  • Net rental income before depreciation: $3,000
  • Add back depreciation: $11,700
  • Assessed rental income: $14,700

This is significantly higher than the $3,000 she would otherwise show. With $14,700 in assessed rental income, Sarah can borrow substantially more. Using a typical serviceability calculator, an extra $11,700 in income could increase her borrowing capacity by over $100,000, depending on the lender and interest rate.

Common Mistakes to Avoid

1. Not Getting a Depreciation Schedule

Many investors miss out on thousands of dollars in deductions simply because they don’t obtain a depreciation schedule. Even older properties may have depreciation potential from renovations or plant and equipment.

2. Assuming All Lenders Treat Depreciation the Same

As mentioned, lender policies vary widely. Relying on a lender that doesn’t add back depreciation can significantly reduce your borrowing power.

3. Forgetting to Update the Schedule After Renovations

If you renovate, you can claim additional depreciation on the new assets and possibly on the structural improvements. An updated schedule ensures you capture all available deductions.

4. Not Claiming Depreciation in Tax Returns

To use depreciation for serviceability, you must be able to demonstrate it. If you haven’t claimed it in past tax returns, you may need to amend previous returns or at least provide the schedule to the lender as evidence of future claims.

5. Overlooking the Impact on Capital Gains Tax (CGT)

Depreciation claimed on capital works reduces the cost base of the property, which can increase your CGT liability when you sell. However, the tax savings over the holding period often outweigh the CGT impact. It’s advisable to consult a tax professional.

Tax and Legal Considerations

ATO Compliance

Ensure your depreciation schedule complies with ATO guidelines. The ATO requires that the schedule be prepared by a qualified professional. Using an unqualified person or self-assessing can lead to penalties.

Changes to Legislation

Stay updated on tax law changes. The Treasury Laws Amendment (Housing Tax Integrity) Act 2017 restricted plant and equipment deductions for second-hand assets in residential investment properties. However, commercial properties and new residential properties are unaffected. Always check the latest ATO rulings.

State-Based Differences

While depreciation is a federal tax matter, state-based taxes like land tax can affect your overall cash flow. Consider these when calculating your net rental position.

How to Choose a Quantity Surveyor

Selecting the right quantity surveyor is crucial. Look for:

  • Membership in AIQS or RICS
  • Experience in residential investment properties
  • Insurance (professional indemnity)
  • Clear fee structure
  • Turnaround time

A good schedule will maximize your deductions legally and provide a detailed breakdown that lenders and the ATO accept.

Integrating Depreciation into Your Investment Strategy

Depreciation should be part of your overall investment strategy, not an afterthought. When evaluating potential investment properties, consider the age, construction type, and existing assets. Newer properties or those with recent renovations typically offer higher depreciation benefits. However, don’t let depreciation alone drive your decision—location, growth potential, and rental demand are equally important.

For investors with multiple properties, depreciation can create a snowball effect. Each property’s depreciation adds to your assessable income, enabling you to borrow more for the next purchase. This is a common strategy among successful property investors.

The Future of Depreciation and Lending

As the Australian property market evolves, lenders are becoming more sophisticated in assessing rental income. Some fintech lenders are using real-time data and automated serviceability calculators that factor in depreciation automatically. However, traditional banks still rely on manual assessments, so presenting a clear depreciation schedule remains essential.

Additionally, with interest rates fluctuating, maximizing your borrowing power through depreciation can be a buffer against tighter lending conditions. In 2023 and 2024, many investors faced reduced borrowing capacity due to rate rises; those who used depreciation effectively were better positioned.

FAQ

1. Can I claim depreciation on an older property?

Yes, you may still be eligible for depreciation on an older property. If the property was built before 1987, you cannot claim capital works deductions unless there have been structural renovations. However, you can claim plant and equipment deductions for assets you have added or that were purchased new by a previous owner after 9 May 2017 (with evidence). A quantity surveyor can assess what’s claimable.

2. How much does a depreciation schedule cost, and is it worth it?

A depreciation schedule typically costs between $400 and $700. The fee is tax-deductible. Given that the average first-year deduction can be $5,000 to $15,000, the schedule often pays for itself many times over. For example, a $10,000 deduction at a 37% tax rate saves $3,700 in tax, far exceeding the cost.

3. Do all lenders add back depreciation when calculating borrowing power?

No, not all lenders add back depreciation. Some lenders add back 100% of depreciation, some add back a portion, and others do not add back at all. It’s important to consult a mortgage broker who can guide you to lenders with favorable policies. This can make a significant difference in your borrowing capacity.

4. Can I use depreciation to increase my borrowing power if I haven’t claimed it before?

Yes. Even if you haven’t claimed depreciation in previous tax returns, you can obtain a depreciation schedule and provide it to your lender. The schedule shows the deductions you are entitled to claim going forward. Some lenders may also consider back-claiming potential if you amend past returns, but this is less common.

5. Does claiming depreciation affect my Centrelink benefits or other income-tested payments?

Depreciation reduces your taxable income, which can affect income-tested benefits. However, for Centrelink purposes, some payments use adjusted taxable income that may add back certain deductions. You should seek advice from a financial counselor or Centrelink directly to understand the impact.

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