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  • Who can claim deductions for the decline in value 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

    Only a holder of a depreciating asset may deduct an amount for its decline in value.

    In most cases, the legal owner of a depreciating asset will be its holder.

    There may be more than one holder of a depreciating asset-for example, joint legal owners of a depreciating asset are all holders of that asset. Each person's interest in the asset is treated as if it were itself the depreciating asset. Each would work out their deduction for decline in value according to their interest-for example, at the cost of the interest to them, not the cost of the asset itself-and according to their use of the asset.

    In certain circumstances, the holder is not the legal owner. Some of these cases are discussed below.

    If you are not sure whether you are the holder of a depreciating asset, contact your professional tax adviser or the ATO.

    Leased luxury cars

    A leased car, either new or second hand, is a luxury car if its cost exceeds the car limit that applies for the income year in which the lease commences. The car limit for 2001-02 is $55,134, see Car limit for certain motor vehicles.

    A luxury car lease (other than a genuine short-term hire arrangement) entered into after 7.30 pm (by legal time in the ACT) on 20 August 1996 is treated as a notional sale and loan transaction.

    The cost or value of the car specified in the lease (or, if the parties were not dealing at arm's length, the amount that could reasonably have been expected to have been paid to purchase the car) is taken to be the cost of the car to the lessee and the amount loaned by the lessor to the lessee to buy the car.

    In relation to the notional loan transaction, the actual lease payments are divided into notional principal and finance charge components. That part of the finance charge component applicable for the particular period (the 'accrual amount') is deductible to the lessee.

    In relation to the notional sale transaction, the lessee is treated as the holder of the luxury car and is entitled to claim a deduction for the decline in value of the car. For the purpose of calculating the deduction, the cost of the car is limited to the car limit for the year in which the lease is granted.

    Any deduction would be reduced to reflect any use of the car other than for a taxable purpose, such as private use.

    If the lessee does not actually acquire the car from the lessor when the lease terminates, the lessee is treated under the rules as disposing of the car by way of sale to the lessor. This constitutes a balancing adjustment event and any assessable or deductible balancing adjustment amount for the lessee must be determined, see What happens if you no longer hold or use a depreciating asset?

    Depreciating assets subject to hire purchase agreements

    For income tax purposes, certain hire purchase agreements entered into after 27 February 1998 are treated as notional sale and notional loan transactions.

    Generally, the cost or value of the goods stated in the hire purchase agreement (or, if the parties were not dealing with each other at arm's length, the amount the notional buyer could reasonably have been expected to pay to buy the goods under an arm's length sale) is taken to be the cost of the goods to the hirer (the notional buyer) and the amount loaned by the financier (the notional seller) to the hirer to buy the goods. If the goods are depreciating assets, this same amount is taken to be the first element of cost for the purposes of calculating any deduction for decline in value. It would be subject to cost adjustments, including the car limit, see The cost of a depreciating asset.

    In relation to the notional loan, the periodic payments are separated into principal and interest, the interest being deductible to the hirer.

    In relation to the notional sale, the hirer is treated as the owner of the goods. Under the UCA rules, if the goods are depreciating assets, the hirer is the holder and is able to claim a deduction for decline in value if the asset is used for a taxable purpose, see When does a depreciating asset start to decline in value?

    If the hirer acquires the goods under the agreement, the hirer continues to be treated as the owner. Actual transfer of legal title to the goods from the financier to the hirer is not treated as a disposal or acquisition.

    On the other hand, if the hirer does not legally acquire the goods under the arrangement, the goods are treated as being sold back to the financier at their market value at that time. This constitutes a balancing adjustment event for the hirer and an assessable or deductible balancing adjustment amount may arise, see What happens if you no longer hold or use a depreciating asset?

    The notional loan amount under a hire purchase agreement is treated as limited recourse debt, see Limited recourse debt arrangements.

    Leased depreciating assets fixed to land

    If you are the lessee of a depreciating asset and it is affixed to your land, under property law you become the legal owner of the asset. As the legal owner you are taken to hold the asset. However, an asset may have more than one holder. Despite the fact that the leased asset is affixed to your land, if the lessor of the asset (often a bank or finance company) has a right to recover it, then they too are taken to hold the asset as long as they have that right to recover it. You and the lessor-each being a holder of the depreciating asset-would calculate the decline in value of the asset based on the cost to each of you.

    Example: Holder of leased asset fixed to land

    Jo owns a parcel of land. A finance company leases some machinery to Jo who installs it on her land and pays the installation costs. Under the lease agreement, the finance company has a right to recover the machinery if Jo defaults on her lease payments.

    The finance company holds the machinery as it has a right to remove the machinery from the land. The finance company is entitled to deductions for the decline in value of the machinery based on the cost of the machinery to it. However, Jo also holds the machinery as it is attached to her land. She is entitled to a deduction for the decline in value based on the cost to her to hold the machinery. This would not include her lease payments but would include the cost of installing the machinery-see The cost of a depreciating asset for more information about what amounts form part of the cost of a depreciating asset.

    End of example

    Depreciating assets which improve or are fixed to leased land

    If a depreciating asset is fixed to leased land and the lessee has a right to remove it, they are the holder while the right to remove the asset exists.

    Example: Holder of depreciating asset fixed to leased land

    Jo leases land from Bill who owns the land. Jo purchases some machinery and fixes it to the land. Under property law the machinery is treated as part of the land so Bill is its legal owner.

    However, under the terms of her lease, Jo can remove the machinery from the land at any time. Because she has acquired and fixed the machinery to the land and has a right to remove it, Jo holds the machinery as long as the right to remove it exists.

    End of example

    If a lessee or owner of certain other rights over land (for example, an easement) improves the land with a depreciating asset, they are the holder of the asset if the asset is for their own use even though they have no right to remove it from the land. They remain the holder as long as the lease or right exists.

    Example: Holder of depreciating asset which improves leased land

    Jo leases land from Bill to use for farming. Jo installs an irrigation system on the land which is an improvement to the land. While Bill is the legal owner under property law as the irrigation system is part of his land, Jo holds the irrigation system and, even though she has no right to remove it under her contract with Bill, she may deduct amounts for its decline in value for the term of the lease because:

    • she improved the land
    • the improvement is for her use.
    End of example

    Partnership assets

    The partnership and not the partners or any particular partner is taken to be the holder of a partnership asset regardless of its ownership. A partnership asset is one held and applied by the partners exclusively for the purposes of the partnership and in accordance with the partnership agreement.

    Last modified: 11 Dec 2019QC 27399