The IRD allows you to run your investment property as a business. This means that you can claim the expenses incurred against the income received for it, in order to reduce tax liability.
Depreciation is an expense that can be claimed to reduce taxable income.
Let’s have a look at an example of how depreciation can improve your cashflow:
Rental income of $400 /week $20,800
Less cash expenses (insurance, rates, interest, etc) 10,000
Income before depreciation (cash in your pocket) 10,800
Less Non-cash expense (depreciation) 5,000
Taxable income after depreciation (what the IRD taxes you on) $5,800
Using this example, you can see that the end result will be that less tax is paid on the income received once depreciation is claimed.
Note that the actual amount of tax paid will depend on the type of ownership structure that is in place for the property. Following is a brief overview of possible ownership structures.
Property is owned by an individual or a partner in a partnership.
In this instance, any gain or loss in income due to depreciation claimed is transferred through to the individual to claim on their individual tax return.
Using the above scenario as an example:
Income before depreciation (cash in your pocket) $10,000
Less estimated tax paid (@33% tax rate) -3,564
Income before depreciation (cash in your pocket) 7,236
Or if depreciation is claimed….
Less Non-cash expense (depreciation) -5,000
Taxable income after depreciation 5,800
Less estimated tax paid (@33% tax rate) -1,914
Income after depreciation claimed (cash in your pocket) $8,886
In this example, you gain an additional $1,650 in income for the year!!
Property is owned by a ‘Company’ or ‘Look through Company’ (LTC)
If a rental property is owned by a partnership of 2 or more people, then usually the partnership will obtain an IRD number and will file an IR7 Income tax return each year the property is owned. It is this return that will show the individuals share of depreciation claimed and the resulting income or loss so they can then claim it. (Note: Actual scenarios may vary. You will need to consult with your Accountant to obtain accurate information that is specific to your individual situation.)
Property is owned by a ‘Trust’
In this situation, any depreciation claimed, and the resulting income or loss, is retained in the trust and is not passed through to the individual.