As a general rule, if you purchase capital assets for the purposes of earning your income, you can’t claim an immediate tax deduction. Instead, you need to write-off the cost of the asset over a period of time, typically several years. This tax deductible write-off is called depreciation.
Calculating depreciation can be a fiddly and time-consuming process because of the complexity of the rules and the need to roll forward calculations on a year by year basis. For that reason, many prefer to leave the task of working our tax depreciation to their tax agent, but it can’t do any harm to understand the basis, so here is our beginners guide to tax depreciation.
You may be able to depreciate assets if you earn income in any of the following ways:
- You run a business and use assets as part of that business
- You are employed in a job and use the asset as part of your job
- You rent out an investment property which contains assets of a capital nature
The type of assets you might look to write-off is extremely varied, depending on how you earn your taxable income, but includes most items with a limited life which can be expected to decline in value over time. In the context of a retail business this might include:
- Cash registers and other POS devices
- Delivery vans
- Store fittings and fixtures
- In store security systems
- Accounting software
- Items of technology such as computers, laptops, phones and printers
- Office furniture
The cost of an item for the purposes of working out your depreciation includes the amount you paid for the asset, plus any additional costs you incurred in transporting and installing the asset and costs relating to getting the asset into a useable condition (such as initial repairs).
You can only claim depreciation to the extent that the asset is used to earn your assessable income. If the asset is also used for private or domestic purposes, you’ll need to apportion the depreciation charge and can only claim the business related element (for instance, if you van and use it half in your business and half for private purposes, you can only claim depreciation on half the cost).
There are two sets of rules for working out depreciation, the general rules and special, simplified rules for small businesses. There are also additional, temporary, concessional rules that allow either an immediate write-off or accelerated write-off for businesses with a turnover of less than $500 million.
Under the general depreciation rules, capital assets must be written-off over the effective life of the asset, which varies depending on the type of asset involved. Each year, the ATO produces a comprehensive list of effective lives for assets (the current one is TR 2020/3). You can either use this list to determine the effective life of your assets or you can self-assess the effective life if you disagree with the ATO list.
There are two ways to calculate depreciation. You can either use the prime cost (or straight line) method, by which the cost is written off in equal amounts over the asset’s effective life or you can use the diminishing value method, by which the base value of the asset diminishes each year as it is reduced by the amount of the previous year’s depreciation.
The diminishing value method will produce larger deductions in the initial years of ownership but smaller ones later in the asset’s effective life. The straight line method produces a consistent deduction every year of the effective life.
Simplified rules for small businesses
If you have a small business (defined as one with an aggregate turnover of less than $10m), you can take advantage of different, simplified rules.
Assets costing more than the instant asset-write-off threshold (see below) are all added to pool of assets and can be depreciated at 15% in the first year of ownership and 30% in each subsequent year.
If the balance of the small business depreciation pool, before deducting current year depreciation, is less than the instant asset write-off threshold (currently $150,000) at the end of the financial year, the entire pool can be written off, which can generate a valuable and substantial deduction against profits. Note that the instant asset write-off threshold falls to $1,000 on 1 January 2021, so the ability to write-off the pool at the end of the next financial year will be greatly constrained.
Instant asset write-off
Through until 31 December 2020, most businesses can continue to immediately write-off capital purchases for items costing less than $150,000. The current tax break is available to all businesses with an aggregated turnover of less than $500 million and enables businesses to immediately deduct against current year profits items as diverse as retail fit-outs, motor vehicles, tech purchases (such as computers, laptops, etc) and security systems.
However, from 1 January 2020 onwards, the tax break in its current form ends. From that date, an immediate deduction is only available for items costing less than $1,000 and eligibility is restricted to businesses with an aggregate turnover of just $10 million (in other words, small businesses that qualify for the simplified depreciation rules explained above).
The accelerated depreciation scheme allows eligible businesses to write-off substantial capital purchases much faster than normal and will offer a useful – if less generous – opportunity once the instant asset write-off drops back to $1,000 on 1 January 2020. The scheme is available now and will through until 30 June 2021 for all businesses with an aggregate turnover of less than $500 million. “Accelerated deprecation” works differently depending on the size of your business:
- if you a small business (aggregate turnover of less than $10 million), you can claim 57.5 per cent of the cost of the asset (for those assets that cost more than the instant asset write-off threshold) in the year you acquire and first use or install the asset. The balance of the cost is then written off in future years in the usual way;
- businesses that are not small businesses can claim a deduction of 50 per cent of the cost of the asset, plus half of the normal depreciation on the asset for that year. The balance of the cost is then written off over the effective life of the asset.
Only new assets qualify (second-hand assets are excluded) but there is no limit on the cost of qualifying assets.
You normally need to keep your tax records for five years from 31 October following the end of the tax year.
For depreciating assets, though, you may need to keep records a lot longer. In fact, you’ll need to keep records for the entire period over which you claim deductions for the decline in value of those assets. Then, you’ll need to keep those records for a further five years from the date of your last claim!