How to Calculate Depreciation for Negative Gearing

Negative gearing is a tax strategy used by investors to reduce their taxable income by claiming losses on rental properties. Depreciation is a key component of negative gearing calculations, as it helps offset rental income and increase tax deductions. This guide explains how to calculate depreciation for negative gearing, including the formulas, assumptions, and practical applications.

What is Negative Gearing?

Negative gearing occurs when the total expenses of a rental property exceed the rental income. In tax systems that allow for negative gearing, investors can claim these losses against their personal income, effectively reducing their taxable income.

The key components of negative gearing are:

Rental income
Expenses (including depreciation)
Tax rate

The negative gearing ratio is calculated by dividing the total expenses by the rental income. A ratio below 1 indicates negative gearing.

How Depreciation Affects Negative Gearing

Depreciation is the process of allocating the cost of a property over its useful life. It's a key expense in negative gearing calculations because it helps offset rental income and increase tax deductions.

There are two main types of depreciation:

Straight-line depreciation: Equal annual depreciation over the property's useful life
Prime cost depreciation: Depreciation based on the original purchase price

Depreciation can significantly impact your negative gearing ratio, making it an important factor to calculate accurately.

Calculating Depreciation

The depreciation amount can be calculated using the following formula:

Depreciation = (Original Cost - Salvage Value) / Useful Life

Where:

Original Cost is the purchase price of the property
Salvage Value is the estimated value of the property at the end of its useful life
Useful Life is the number of years the property is expected to be used

For negative gearing purposes, depreciation is typically calculated annually and added to other expenses to determine the total negative gearing amount.

Step-by-Step Guide

Step 1: Determine the Property's Original Cost

Find the purchase price of the rental property, including any additional costs such as renovations or legal fees.

Step 2: Estimate the Salvage Value

Determine the estimated value of the property at the end of its useful life. This can be based on market research or comparable properties.

Step 3: Determine the Useful Life

Decide on the useful life of the property, typically 25-50 years for residential properties.

Step 4: Calculate Annual Depreciation

Use the formula above to calculate the annual depreciation amount.

Step 5: Combine with Other Expenses

Add the annual depreciation to other rental expenses (council rates, insurance, maintenance, etc.) to get the total annual expenses.

Step 6: Calculate Negative Gearing Ratio

Divide the total annual expenses by the annual rental income to determine the negative gearing ratio.

Example Calculation

Let's walk through an example calculation for a rental property with the following details:

Item	Value
Original Cost	$500,000
Salvage Value	$50,000
Useful Life	50 years
Annual Depreciation	$9,000
Other Annual Expenses	$20,000
Total Annual Expenses	$29,000
Annual Rental Income	$25,000
Negative Gearing Ratio	1.16

In this example, the negative gearing ratio is 1.16, which means the property is negatively geared. The investor can claim the $4,000 difference against their personal income for tax purposes.

FAQ

What is the difference between straight-line and prime cost depreciation?: Straight-line depreciation allocates equal annual depreciation over the property's useful life, while prime cost depreciation is based on the original purchase price and may vary by year.
How does depreciation affect my tax return?: Depreciation reduces your taxable income by increasing your deductible expenses. This can lead to significant tax savings, especially for investors in negatively geared properties.
Can I claim depreciation on a rental property I've owned for less than a year?: Yes, you can claim depreciation for the portion of the year you've owned the property, but you'll need to adjust the calculation accordingly.
What happens if my rental property is sold before the end of its useful life?: If you sell the property, you'll need to adjust your depreciation calculations to account for the remaining useful life of the property.
Are there any limitations on negative gearing?: Yes, different countries and tax systems have different rules and limitations on negative gearing. It's important to consult with a tax professional to understand the specific rules that apply to you.