How Depreciation Affects Capital Gains Tax
Depreciation claimed during ownership reduces your cost base and increases your CGT liability when you sell.
The Depreciation-CGT Connection
Depreciation is a powerful non-cash tax deduction that reduces your taxable income every year. However, there's a trade-off:
- Annual benefit: Depreciation deductions reduce your taxable income now
- Future cost: Depreciation claimed reduces your cost base, increasing your capital gain (and CGT) when you sell
How Depreciation Reduces Your Cost Base
When calculating CGT, your cost base is:
Cost Base = Purchase price + Capital improvements + Buying/selling costs - Depreciation claimed
Purchase price: $600,000
Capital improvements: $50,000
Depreciation claimed over 10 years: $80,000
Sale price: $900,000
Selling costs: $30,000
Cost base calculation:
$600,000 + $50,000 - $80,000 = $570,000
Capital gain:
$900,000 - $30,000 - $570,000 = $300,000
Without depreciation, capital gain would have been:
$900,000 - $30,000 - $650,000 = $220,000
Depreciation increased capital gain by $80,000
Types of Depreciation and CGT Impact
All depreciation claimed reduces your cost base and increases your capital gain when you sell:
Division 43 – Capital Works Deduction
Building structure: Depreciated at 2.5% per year for 40 years
Examples: Walls, roof, floors, foundation, fixed structural elements
Division 40 – Plant and Equipment
Removable assets: Depreciated over their effective life
Examples: Carpets, appliances, blinds, hot water system, air conditioning
Building construction cost: $400,000
Annual capital works deduction (Division 43): $10,000
Plant and equipment (Division 40): $3,000/year
Claimed for 10 years: $130,000 total
Cost base reduced by $130,000
Capital gain increased by $130,000
Tracking Depreciation for CGT
The ATO requires you to track all depreciation claimed and reduce your cost base accordingly. Keep:
- Depreciation schedules from quantity surveyors
- Annual tax returns showing depreciation claimed
- Records of capital works and plant/equipment deductions
- Updated schedules after renovations or asset purchases
Common Mistakes to Avoid
- Not tracking depreciation claimed: You must reduce your cost base by the exact amount claimed – keep accurate records.
- Assuming depreciation costs more than it saves: In most cases, the 50% discount and time value make depreciation worthwhile.
- Not claiming depreciation at all: Forgoing thousands in annual savings to avoid a smaller future CGT increase.
- Forgetting unclaimed depreciation doesn't reduce cost base: Only amounts actually claimed reduce your cost base.
Mint's Takeaway
- Depreciation claimed reduces your cost base, increasing your capital gain and CGT liability when you sell.
- Despite the CGT impact, depreciation is almost always worthwhile due to the 50% CGT discount and time value of money.
- Tax savings from depreciation are received now; CGT is paid years later.
- Every $1 of depreciation claimed saves $0.37-$0.45 now (depending on tax rate) but costs ~$0.19-$0.23 in extra CGT later.
- If using the 6-year absence rule, claim depreciation aggressively – you get deductions without CGT cost.
- Track all depreciation claimed – only amounts actually deducted reduce your cost base.
- Keep depreciation schedules, tax returns, and records for CGT calculation accuracy.
Mint automatically tracks depreciation claimed and calculates the CGT impact on your cost base – ensuring accurate reporting when you sell.