Property Depreciation and CGT: What Happens When You Sell

Depreciation deductions are one of the most powerful tax benefits available to property investors. But there's a side effect most investors don't fully understand until they sell: every dollar of building depreciation you've claimed reduces your cost base, which directly increases your capital gain — and your tax bill. Here's how it works, what it actually costs you, and why you should still claim every dollar you're entitled to.

Two Types of Depreciation, Two Different Rules

There are two categories of depreciation available to investment property owners, and they're treated very differently when you sell.

Division 43 — Capital Works (Building Depreciation)

Division 43 covers the structural elements of the property itself — the building shell, concrete, brickwork, roofing, internal walls, and fixed improvements. You can claim 2.5% of the original construction cost per year for up to 40 years.

The catch at sale: every dollar of Division 43 you have claimed reduces your cost base. This is the key mechanic most investors don't see coming.

Division 40 — Plant & Equipment (Depreciating Assets)

Division 40 covers removable fixtures and fittings — ovens, dishwashers, air conditioning units, carpets, blinds. These are claimed separately based on each asset's effective life.

Division 40 assets do not reduce the cost base of the property itself. Instead, when the property is sold, each asset goes through a "balancing adjustment" — the ATO compares the asset's written-down tax value against the termination value. This can result in either assessable income or an additional deduction. In practice, for residential properties sold with all fixtures included, your accountant handles this calculation.

This article focuses on Division 43, because it directly and clearly affects your capital gain and is the one most investors are surprised by.

How Division 43 Reduces Your Cost Base

When you sell an investment property, your capital gain is calculated as:

Every dollar of building depreciation you claimed during ownership is subtracted from your cost base, leaving a higher capital gain — and a higher tax bill — when you sell.

A Worked Example

Let's put real numbers to it.

But Here's the Part That Makes Claiming Worth It

At first glance, $13,875 extra tax sounds bad. But compare it against what you received over 10 years by claiming the depreciation:

The 50% CGT discount is the key mechanism that makes claiming worthwhile. The full $75,000 of depreciation you claimed during ownership only adds $37,500 to your taxable capital gain at sale (after the 50% discount). You saved tax on the full $75,000 at your marginal rate while you held it, but only pay CGT on half of it when you sell.

The One Scenario Where It Gets More Complex

If you sell within 12 months of purchase, the 50% CGT discount doesn't apply. In this case, the cost base reduction still happens but you don't get the discount that makes claiming clearly worthwhile. Investors selling short-term should run the numbers carefully with their accountant before assuming the same logic holds.

Common Misconceptions

"I won't claim depreciation to avoid the clawback"

This almost always costs you money. As shown above, the annual tax savings over 10 years ($27,750) more than double the extra CGT at sale ($13,875). Not claiming doesn't make the cost base reduction disappear — it just means you've missed the annual savings for no net gain.

"The ATO reduces my cost base even if I don't claim"

For Division 43, this is not correct. The cost base is only reduced by the amount you actually claimed, not the amount you were entitled to claim. If you never lodged a claim, your cost base stays higher. But so does your annual tax bill — you've effectively given up a deduction for nothing.

"Depreciation is only worth it for newer properties"

While Division 40 (plant and equipment) is generally only claimable on new assets, Division 43 (capital works) can be claimed on any residential property built after 16 September 1987 — regardless of whether it's new or second-hand. A 1995-built property can still have significant capital works claims remaining.

What You Should Do

• Get a depreciation schedule if you haven't already. A quantity surveyor typically charges $500–800 and the schedule covers the entire time you own the property. The first year's tax saving usually covers the cost.
• Keep the schedule updated if you make improvements to the property — renovations and additions create additional capital works claims.
• Tell your accountant at sale what Div 43 you've claimed. They need this figure to calculate your adjusted cost base correctly.
• Don't make the decision to claim or not claim alone — this article explains the concept, but every investor's situation is different based on their tax bracket, hold period, and plans for the property.

Sources: ATO — Cost base adjustments for capital works; ATO — CGT when selling your rental property; BMT Tax Depreciation — Depreciation and CGT

Written by Amit Narang, Mortgage Broker | Credit Representative 558902 of Outsource Financial Pty Ltd (ACL 384324)