When selling an investment property, many investors assume their capital gain is simply the difference between the purchase price and the selling price. However, an important tax adjustment must be made: adding back depreciation claimed over the years to correctly calculate capital gains tax (CGT).
How Depreciation Affects Capital Gains Tax
Depreciation allows property investors to claim deductions over time for the wear and tear of the building and its fixtures. In Australia, depreciation falls under two key categories:
- Capital Works Deduction (Division 43) – Applies to the building structure, typically depreciated at 2.5% per year over 40 years.
- Plant and Equipment Depreciation (Division 40) – Covers fixtures and fittings such as appliances, carpets, and blinds, which have varying depreciation rates.
While depreciation helps reduce taxable rental income each year, it also lowers the property’s cost base. This means that when the property is sold, the total depreciation claimed under Capital Works Deductions must be added back, increasing the taxable capital gain.
Why It Matters
Many investors forget about this adjustment and assume their capital gain is lower than it actually is. Since the cost base is reduced by the total depreciation claimed, the capital gain is effectively increased, leading to a higher CGT liability.
This can be significant, especially for long-term property investors who have claimed depreciation for many years. The impact can be softened by the 50% CGT discount if the property has been held for more than 12 months, but the add-back rule still applies.
Planning for CGT Impacts
To avoid surprises at tax time, investors should:
- Track Depreciation Deductions – Keep a record of all depreciation claimed over the years.
- Factor in Depreciation When Planning a Sale – Understanding how much will be added back can help with tax planning.
- Time the Sale Strategically – Selling in a lower-income year or using capital losses to offset gains can reduce the tax burden.
- Consult your SWU Group Tax Professional – A qualified accountant can provide guidance on CGT implications and strategies to minimise tax.
Final Thoughts
Depreciation is a valuable tax-saving tool while holding an investment property, but it comes with implications when selling. Investors must account for depreciation adjustments when calculating CGT to ensure they accurately assess their tax liability and make informed financial decisions.
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