Deduction for decline in value of depreciating assets

You can deduct an amount equal to the decline in value for an income year of a depreciating asset that you held for any time during the year. However, your deduction is reduced to the extent your use of the asset is for other than a taxable purpose. A taxable purpose is the purpose of producing assessable income, the purpose of exploration or prospecting, the purpose of mining site rehabilitation, or environmental protection activities. If you own a rental property, the taxable purpose will generally be for the purpose of producing assessable income.

Some items found in a rental property are regarded as part of the setting for the rent producing activity and are not treated as separate assets in their own right. However, a capital works deduction may be allowed for some of those items - see Capital works deductions.

How do you work out your deduction?

You work out your deduction for the decline in value of a depreciating asset using either the prime cost or diminishing value method. Both methods are based on the effective life of the asset. The decline in value calculator on our website will help you with the choice and the calculations.

The diminishing value method assumes that the decline in value each year is a constant proportion of the remaining value and produces a progressively smaller decline over time. The formula for working out decline in value using this method is:

Base value × (days held ÷ 365) × (150% ÷ asset's effective life)

Base value: For the income year in which an asset is first used or installed ready for use for any purpose, the base value is the asset's cost. For a later income year, the base value is the asset's opening adjustable value plus any amounts included in the asset's second element of cost for that year.

Days held: Can be 366 in a leap year.

Note: At the time of printing this publication, there was legislation before Parliament which will change the above formula. The '150%' will become '200%' for depreciating assets that you:

• started to hold under a contract entered into on or after 10 May 2006
• constructed, with construction starting on or after that date, or
• started to hold in some other way on or after that date.

However, the new formula does not apply in some cases - such as if you dispose of and reacquire an asset just so the decline in value of the asset can be worked out using the new formula.

If you want to know whether the law has come into effect, phone the Personal Tax Infoline

An asset's cost has two elements. The first element of cost is, generally, amounts you are taken to have paid to hold the asset, such as the purchase price. The second element of cost is, generally, the amount you are taken to have paid to bring the asset to its present condition, such as the cost of capital improvements to the asset. If more than one person holds a depreciating asset, each holder works out their deduction for the decline in value of the asset based on their interest in the asset and not on the cost of the asset itself.

The adjustable value of a depreciating asset is its cost (first and second elements) less its decline in value up to that time. Adjustable value is similar to the concept of undeducted cost used in the former depreciation provisions. The opening adjustable value of an asset for an income year is generally the same as its adjustable value at the end of the previous income year.

The prime cost method assumes that the value of a depreciating asset decreases uniformly over its effective life. The formula for working out decline in value using the prime cost method is:

Asset's cost × (days held ÷ 365) × (100% ÷ asset's effective life)

Note: Can be 366 in a leap year.

The formula under the prime cost method may have to be adjusted if the cost, effective life or adjustable value of the asset is modified. For more information, see the Guide to depreciating assets 2005-06 (NAT 1996-6.2006).

Under either method, the decline in value of an asset cannot amount to more than its base value in any income year.

If you use a depreciating asset for other than a taxable purpose - for example, you use the same lawn mower at both your rental property and your private residence - you are allowed only a partial deduction for the mower's decline in value, based on what percentage of the mower's total use occurred at your rental property.

Effective life

Generally, the effective life of a depreciating asset is how long it can be used by any entity for a taxable purpose, or for the purpose of producing exempt income or non-assessable non-exempt income:

• having regard to the wear and tear you reasonably expect from your expected circumstances of use
  
• assuming that it will be maintained in reasonably good order and condition, and
  
• having regard to the period within which it is likely to be scrapped, sold for no more than scrap value or abandoned.

Effective life is expressed in years, including fractions of years. It is not rounded to the nearest whole year.

For most depreciating assets you can choose to work out the effective life yourself or to use an effective life determined by the Commissioner.

The sort of information you could use to make an estimate of effective life of an asset is listed in the Guide to depreciating assets 2005-06 (NAT 1996-6.2006).

In making his determination, the Commissioner assumes the depreciating asset is new and has regard to general industry circumstances of use.

Taxation Ruling TR 2000/18 - Effective life of depreciating assets, lists the Commissioner's determination of effective life for various depreciating assets. Taxation Ruling TR 2000/18 came into force on 1 January 2001.

Because the Commissioner often reviews the determinations of effective life, the determined effective life may change from the beginning of, or during, an income year. You need to work out which version of the schedule accompanying Taxation Ruling TR 2000/18 to refer to for a particular asset's determined effective life. As a general rule, use the version of the schedule that is in force at the time you:

• entered into a contract to acquire the depreciating asset
• otherwise acquired it, or
• started to construct it.

Replacements

It was the longstanding practice to treat the initial purchase of certain assets as not depreciable but to allow an immediate deduction for the cost of their replacement. The practice principally related to low-cost items that had very long or indeterminate lives, were difficult to keep track of and were subject to frequent replacement through loss or breakage - for example, crockery, bedding and linen.

However, the replacement basis for deductions is no longer available for assets you first use (or have installed ready for use) to produce income after 31 December 2000.

An immediate deduction is available for depreciating assets costing $300 or less which you use predominantly in deriving non-business income (including rental income), if certain conditions are met - see Immediate deduction for certain non-business depreciating assets costing $300 or less. Also, you may write off assets costing less than $1,000 through a low-value pool - see Low-value pooling.

Immediate deduction for certain non-business depreciating assets costing $300 or less

The decline in value of certain depreciating assets costing $300 or less is their cost. This means you get an immediate deduction for the cost of the asset to the extent that you use it for a taxable purpose during the income year in which the deduction is available.

The immediate deduction is available if all of the following tests are met in relation to the asset:

• it costs $300 or less
  
• you use it mainly for the purpose of producing assessable income that is not income from carrying on a business (for example, rental income where your rental activities do not amount to the carrying on of a business)
  
• it is not part of a set of assets you start to hold in the income year that costs more than $300, and
  
• it is not one of a number of identical, or substantially identical, assets that you start to hold in the income year that together cost more than $300.

If you hold an asset jointly with others and the cost of your interest in the asset is $300 or less, you can claim the immediate deduction even though the depreciating asset in which you have an interest cost more than $300 - see Partners carrying on a rental property business.

 

For further information about immediate deductions for depreciating assets costing $300 or less, refer to the publication Guide to depreciating assets 2005-06 (NAT 1996-6.2006).

Low-value pooling

You can allocate low-cost assets and low-value assets relating to your rental activity to a low-value pool. A low-cost asset is a depreciating asset whose cost is less than $1,000 (after GST credits or adjustments) at the end of the year in which you start to use it, or have it installed ready for use, for a taxable purpose. A low-value asset is a depreciating asset that is not a low-cost asset and:

• that has an opening adjustable value for the current year of less than $1,000, and
  
• for which you have worked out any available deductions for decline in value under the diminishing value method.

You work out the decline in value of an asset you hold jointly with others based on the cost of your interest in the asset. This means if you hold an asset jointly and the cost of your interest in the asset or the opening adjustable value of your interest is less than $1,000, you can allocate your interest in the asset to your low-value pool. Once you choose to create a low-value pool and allocate a low-cost asset to it, you must pool all other low-cost assets you start to hold in that income year and in later income years. However, this rule does not apply to low-value assets. You can decide whether to allocate low-value assets to the pool on an asset-by-asset basis.

Once you have allocated an asset to the pool, it remains in the pool.

Once an asset is allocated to a low-value pool it is not necessary to work out its adjustable value or decline in value separately. Only one annual calculation for the decline in value for all of the depreciating assets in the pool is required.

You work out the deduction for the decline in value of depreciating assets in a low-value pool using a diminishing value rate of 37.5%.

For the income year you allocate a low-cost asset to the pool, you work out its decline in value at a rate of 18.75%, or half the pool rate. Halving the rate recognises that assets may be allocated to the pool throughout the income year and eliminates the need to make separate calculations for each asset based on the date it was allocated to the pool.

When you allocate an asset to the pool, you must make a reasonable estimate of the percentage of your use of the asset that will be for a taxable purpose over its effective life (for a low-cost asset) or the effective life remaining at the start of the income year for which it was allocated to the pool (for a low-value asset). This percentage is known as the asset's taxable use percentage.

It is this taxable use percentage of the cost or opening adjustable value that is written off through the low-value pool.

For further information about low-value pooling, including how to treat assets used only partly to produce assessable income and how to treat the disposal of assets from a low-value pool, refer to the Guide to depreciating assets 2005-06 (NAT 1996-6.2006).

If you are an individual who owns or has co-ownership of a rental property, you claim your low-value pool deduction for rental assets at item D6 on your tax return (not at item 20 on your tax return (supplementary section)).

What happens if you no longer hold or use a depreciating asset?

If you cease to hold or to use a depreciating asset, a balancing adjustment event will occur. If there is a balancing adjustment event, you need to work out a balancing adjustment amount to include in your assessable income or to claim as a deduction.

A balancing adjustment event occurs for a depreciating asset if:

• you stop holding it - for example, if the asset is sold, lost or destroyed
  
• you stop using it and expect never to use it again
  
• you stop having it installed ready for use and you expect never to install it ready for use again
  
• you have not used it and decide never to use it, or
  
• a change occurs in the holding or interests in an asset which was or is to become a partnership asset.

You work out the balancing adjustment amount by comparing the asset's termination value (such as the proceeds from the sale of the asset) and its adjustable value at the time of the balancing adjustment event. If the termination value is greater than the adjustable value, you include the excess in your assessable income. (If you are an individual who owns or has co-ownership of a rental property, you show such assessable amounts at item 22 Other income on your tax return (supplementary section) - not at item 20.)

If the termination value is less than the adjustable value, you can deduct the difference.

See the Guide to depreciating assets 2005-06 (NAT 1996-6.2006) for further information about balancing adjustments.

Note:

If a balancing adjustment event happens to a depreciating asset that you used at some time other than for income-producing purposes - for example, privately - a capital gain or loss might arise to the extent that you so used the asset.

See Guide to capital gains tax 2005-06 (NAT 4151-6.2006) for further information about capital gains tax and depreciating assets.

Purchase and valuation of second-hand assets

If you purchase a second-hand asset you can generally claim a deduction based on the cost of the asset to you.

Where you purchase a rental property, the most objective means of establishing your cost of depreciating assets acquired with the property is to have their value, as agreed between the contracting parties, specified in the sale agreement. If separate values for depreciating assets are not included in the sale agreement for your rental property when you purchase it, you may be required to demonstrate the basis of your valuation.

Generally, independent valuations that establish reasonable values for depreciating assets satisfy Tax Office requirements. In the absence of an independent valuation, you may need to demonstrate that your estimate provided a reasonable value. Considerations would include the market value of the asset compared to the total purchase price of the property.

Working out your deductions for decline in value of depreciating assets

The Guide to depreciating assets 2005-06 contains two worksheets (Worksheet 1 - depreciating assets and Worksheet 2 - low-value pool) that you can use to work out your deductions for decline in value of depreciating assets.