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  • The cost of a depreciating asset

    Attention

    Warning:

    This information may not apply to the current year. Check the content carefully to ensure it is applicable to your circumstances.

    End of attention

    To work out the decline in value of a depreciating asset, you need to know its cost.

    Under the UCA, the cost of a depreciating asset has 2 elements.

    The first element of cost is, broadly, amounts you are taken to have paid to hold the asset, such as the purchase price, and any additional amounts you spend on transporting it or installing it in position. It is worked out at the time you begin to hold the asset. The second element of cost is capital expenditure incurred after that time, such as a cost of improving the asset.

    Example: First and second elements of cost (ignoring any GST impact)

    Terry purchases a car for $45,000. The first element of cost is $45,000. If Terry installs a car alarm in the vehicle 2 months later at a cost of $1,500, that amount will be included in the second element of cost of the car as it was incurred after he began to hold the car.

    End of example

    The cost of a depreciating asset includes not only amounts you pay but also the market value of any non-cash benefits you provide in relation to the asset. It would also include a liability you incur to pay an amount or to provide a non-cash benefit.

    Cost is impacted by:

    • amounts of input tax credits for which you are or become entitled – see GST input tax credits
    • expenditure not of a capital nature or
    • any amount that you can deduct or which is taken into account in working out a deductible amount under provisions outside the UCA.

    Example: Expenditure not of a capital nature and deductible outside the UCA

    Carolyn uses a motor vehicle for her business. As a result of Carolyn's use of the vehicle, she needs to replace the tyres. The cost of replacing the tyres is not included in the second element of the vehicle's cost because it would ordinarily be deductible under the repair provisions.

    End of example

    There are special rules to work out the cost of depreciating assets in certain circumstances. Some of the common cases are covered below. If you are not sure of the cost of a depreciating asset, contact your professional tax adviser or the ATO.

    Recoupment of cost

    Recoupment of any amount included in the cost of a depreciating asset is included in assessable income.

    GST input tax credits

    If the acquisition or importation of a depreciating asset constitutes a creditable acquisition or a creditable importation, the cost or opening adjustable value of the asset is reduced by any input tax credit you are, or become, entitled to in relation to its acquisition or importation. For an explanation of opening adjustable value, see Methods of working out decline in value.

    If the cost of a depreciating asset is taken to be its market value (such as for assets acquired under a private or domestic arrangement), the market value is reduced by any input tax credit to which you would be entitled had the acquisition been solely for a creditable purpose.

    Similarly, any input tax credit you are entitled to claim in relation to the second element of a depreciating asset's cost reduces the cost or opening adjustable value of the asset.

    Certain adjustments under the GST legislation reduce or increase the cost or opening adjustable value of the asset. Other adjustments are treated as an outright deduction or income.

    Car limit for certain motor vehicles

    Cars designed mainly for carrying passengers are subject to a car limit. If the first element of cost exceeds the car limit for the income year in which you start to hold it (after any adjustments required for acquisition discounts, see Car acquired at a discount and for any input tax credit or adjustment, see GST input tax credits), that first element of cost is reduced to the car limit. The car limit also applies under the luxury car lease rules, see Leased luxury cars. It does not apply in certain circumstances to some cars fitted out for transporting disabled people.

    The car limit is $55,134 for this income year.

    When in time a balancing adjustment event occurs for the car, the termination value must be adjusted under a special formula, see Balancing adjustment rules for cars.

    Car acquired at a discount

    If a car is acquired at a discount, the first element of its cost may be increased by the amount of the discount.

    This will happen to the extent that any portion of the discount (the discount portion) is referable to the disposal for less than market value of another asset (for example, a trade-in) for which any entity has deducted or can deduct an amount at any time.

    This rule does not apply to some cars fitted out for transporting disabled people.

    The adjustment is only made if the cost of the car (after GST credits or adjustments) plus the discount portion exceeds the car limit. A car's cost is not otherwise affected by an acquisition discount for other reasons.

    When in time a balancing adjustment event occurs for the car, the termination value must be increased by the same discount portion, see Balancing adjustment rules for cars.

    Example: Car acquired at a discount (ignoring any GST impact)

    Kristine arranges to buy a $60,000 sedan for business use from Greg, a car dealer. She offers the station wagon she is using for this purpose, worth $20,000, as a trade-in. Greg agrees to reduce the price of the sedan to below the car limit if Kristine accepts less than market value for the trade-in. Kristine agrees to accept $15,000 for the trade-in and the price of the sedan is reduced to $55,000.

    The pre-discount price of the sedan is more than the car limit so the first element of the car's cost is increased by the amount of the discount to $60,000. As the first element of cost then exceeds the car limit, it must be reduced to the car limit for the income year.

    The termination value of the wagon would be taken to be the market value of $20,000.

    End of example

    Non-arm's length and private or domestic arrangements

    If you acquire a depreciating asset for more than its market value and do not deal at arm's length with another party to the transaction or if you acquire a depreciating asset under a private or domestic arrangement (for example, as a gift from a family member), the first element of cost is the market value of the asset at the time you start to hold it-see GST input tax credits for information on market value.

    These rules also apply to the second element of a depreciating asset's cost. For example, if something is done to improve your depreciating asset under a private or domestic arrangement, the second element of the asset's cost is the market value of the improvement when it is made.

    Note that there are special rules for working out the effective life and decline in value of a depreciating asset acquired from an associate, such as a spouse or partner-see Depreciating asset acquired from an associate.

    Depreciating asset acquired with other property

    If you pay an amount for a depreciating asset and something else, only that part of the payment that is reasonably attributable to the depreciating asset is treated as being paid in relation to it. This applies to first and second elements of cost.

    The ATO generally accepts independent valuations as a basis for this apportionment. However, if there is no independent valuation, you may need to demonstrate that your apportionment of the amount paid is reasonable. Apportionment on the basis of the market values of the various items for which the payment is made will generally be reasonable.

    Example: Apportionment of cost

    Sam undertakes to pay an upholsterer $800 for a new desk and $300 to re-upholster a chair. He negotiates a trade discount of $100. The $1000 paid could be apportioned between:

    • the first element of cost of the desk
    • the second element of cost of the chair

    based on the relative market values of the desk and the labour and materials used to upholster the chair.

    End of example

    Hire purchase agreements

    For income tax purposes, hire purchase transactions entered into after 27 February 1998 are treated as a sale of goods by the financier (or hire purchase company) to the hirer, financed by a loan from the financier to the hirer.

    If the subject property is a depreciating asset, the hirer is treated as the holder of the depreciating asset and is entitled to deductions for the decline in value. The cost of the depreciating asset for this purpose is taken to be the cost or value stated in the hire purchase agreement or, if the dealing was not at arm's length, the amount that could have been expected to have been paid to buy the goods under an arm's length dealing, see Depreciating assets subject to hire purchase agreements.

    Death of the holder

    If a depreciating asset starts being held by you as a legal personal representative (say, as the executor of an estate) as a result of the death of the former holder, the cost of the asset is its adjustable value at the time the former holder died, see Methods of working out decline in value for an explanation of adjustable value.

    If you start to hold the depreciating asset because it passes to you as a beneficiary of the estate or as a surviving joint tenant, the cost of the asset is the market value when you started to hold it reduced by any capital gain that was ignored when the owner died or when it passed from the legal personal representative. See the Guide to capital gains tax for information about when these gains can be disregarded.

    Commercial debt forgiveness

    Generally, an amount which you owe is a commercial debt if you can claim a deduction for the interest paid on the debt or you would have been able to claim a deduction for interest if it had been charged. The amount of the commercial debt includes any unpaid interest.

    If a commercial debt is forgiven, you may be required to reduce expenditure deductible under the UCA by all or part of the net forgiven amount. If the reduction of deductible expenditure is to be made in relation to depreciating assets whose decline in value is calculated under the diminishing value method, it reduces the base value from which the decline in value is calculated or, if under the prime cost method, it reduces the cost from which the decline in value is calculated. If the prime cost method is used for the income year in which the change is made and in later years, you need to use the adjusted prime cost formula, see Methods of working out decline in value.

    Last modified: 11 Dec 2019QC 27399