Asset Depreciation: How to Get Your Tax Claim Right

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 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 basics, so here is our beginner's guide to tax depreciation.

The basics

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. This might include:

• Tools and equipment which you use in your trade
• Plant and machinery used in your business
• Items of technology such as computers, laptops, phones and printers, used in either your business or your job
• Office furniture if you maintain an office, either at home or otherwise
• Moveable plant included in an investment property, such as kitchen appliances, hot water systems and air conditioning units

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 work or business related element (for instance, if you purchase a computer and use it half for your job 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 rules for small and medium sized businesses.

General rules

Under the general depreciation rules, you can immediately write-off:

• items costing up to $100 used to earn business income
• items costing up to $300 used to earn income other than from a business (such as equipment you use in your job).

Everything purchased with a cost greater than the above thresholds must generally be written-off over the effective life of the asset, which varies depending on the type of asset involved. However, items that cost between $300 and $1000 may be be able to be 'pooled' together and written off at a rate of 18.75% in the first year and 37.5% in later years. Each year, the ATO produces a comprehensive list of effective lives for assets (the current one is TR 2022/1)). 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 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 and concessions. For the 2023 and earlier years, some of these concessions are available for businesses with turnover up to $5 billion.

For the period 6 October 2020 until 30 June 2023, eligible businesses were able to claim an immediate deduction for depreciating assets in the year the asset was first installed ready for use for a taxable purpose. This concession is available for new assets purchased by businesses with turnover up to $5 billion and for second hand assets for businesses with turnover less than $50 million.

Now that this concession has ceased (from 1 July 2023), small businesses will be able to revert to using the simplified small business depreciation concession. If you opt to use these rules, you can immediately write-off items costing less than $20,000 (for the 2024 and 2025 years). This threshold will reduce to $1,000 after the end of the 2025 year. Assets costing more than the appropriate threshold are added to a small business pool and can be depreciated at 15% in the first year of ownership and 30% in each subsequent year.

Capital works deductions

In addition to all of the above, there is a completely different type of depreciation which is available to write-off the cost of buildings which are used to generate assessable income.

These capital works deductions can be claimed on:

• the cost of constructing a property (excluding the cost of land)
• the costs of any alterations or improvements to the property and
• earthworks for environmental protection, such as embankments or retaining walls

Capital works deductions can be claimed on both commercial properties and residential properties used to generate income (such as rental properties). The cost for capital works purposes is usually written off at a flat 2.5% per annum (over 40 years); a higher 4% rate is available for some industrial buildings and hotels. Typically, residential investment properties must have commenced construction after 1987 in order to qualify for a capital works deduction.

Keeping records

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!