To clarify, I meant: if an Australian tax resident (not temporary tax resident) has income from a foreign rental property, must they always use Australian capital works and capital allowance (AKA depreciation) rules to make claims in their Australian income tax return?

Whether the 'money' is kept offshore is irrelevant to an Australian tax resident (not a temporary tax resident) who derives foreign rental income.  If you're a temporary tax resident you don't need to declare any foreign rental income, and it follows that you can't use any losses.

The tax rules are messy when considering local tax rules.  Layered upon local tax rules are the tax treaties. Most tax agents don't have a clue.

Getting back to my question, the answer is yes, they must use Australian depreciation rules.  I just wanted to see if anyone could come up with a different answer.  I thought there may be some obscure tax ruling on the issue.  I have since discussed this with the ATO and the tax rulings, public and private, all say the same thing.  It makes sense of course.

For an Australian tax resident (not a temporary tax resident) the location of the property is irrelevant for claims made in an Australian income tax return because Australia seeks to tax the income under Australian tax rules therefore they must apply.

Once you've come to grips with the Australian tax rules, then you need to consider the tax rules where the property is located, determine if a tax treaty applies and act according to which rules apply.  If all the rules interact and apply in some way then good luck.

I have seen a few tax returns prepared by others where depreciation deductions have been taken straight from a foreign tax return, converted to AUD and claimed in their Australian tax return.  This is usually done to save time and avoid negotiating a higher fee for preparing the tax return, or they simply don't know the rules.  However, the rules clearly state you must calculate all deductions claimed in your Australian tax return using Australian tax rules, including those for depreciation.  For example, if the overseas property was built before 1985 and no capital improvements have been done since 1992, no capital works deductions would be allowed at all.  Another example: you own a NZ property where there is no CGT, but CGT rules will seek to tax any gain on sale if you are an Australian tax resident (but not a temporary Australian tax resident).

If you are lodging tax returns yourself or through a tax agent, perhaps you should review how any depreciation claims have been determined so you don't receive a nasty surprise from the ATO.

The other interesting thing is you still need a suitably qualified person to prepare a depreciation schedule for an overseas property e.g. a quantity surveyor.  And you can use an Australian quantity surveyor…if you know the construction, improvement and/or asset costs…because you certainly couldn't afford to pay them to visit an overseas property to estimate such costs. You might need a foreign quantity surveyor or equivalent to estimate costs and dates incurred, then an Australian quantity surveyor or accountant to apply the depreciation rules to the costings.  Either way, it certainly complicates ownership of foreign investment properties if you want to maximise your Australian tax benefits.

Enjoy!