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Claw back the cash: general tax depreciation rules explained

by Samuel Williamson

3 min read

It can be discouraging to purchase a new business asset when you know it depreciates from the start. However, understanding the Australian Taxation Office’s (ATO) general depreciation rules can curb any loss caused by expensive asset outlays. Here they are explained.

What is a depreciating asset?

A depreciating asset is one that declines in value over time. This includes most tangible assets with a shelf life, such as computers, tools, furniture and motor vehicles. Under Australian tax law, you can claim a deduction on your taxable income for the depreciated value of assets over time.

How do you determine depreciation value?

The ATO’s general depreciation rules set the amounts (capital allowances) that can be claimed based on the asset’s effective life. These rules apply if you aren’t eligible for simplified depreciation rules, meaning you have an aggregated annual turnover of over $2 million.

The general tax depreciation rules mean you claim deductions on the depreciated worth of capital assets over time in one of two ways:

1. Prime cost

The first general tax depreciation option is called the prime cost method. In this case, the assumption is that a depreciating asset’s value declines uniformly over its effective life (i.e. depreciating by equal amounts each year).

2. Diminishing value

The second option – the diminishing value method – involves more gradation. Tracking reality, it assumes that an asset’s worth drops sharply in the early years. The result: higher deductions at the start through aggressive upfront claims at the expense of consistency. In time, the deductions taper off.

For a visual of how the methods differ, this ATO graph traces a straight line for prime cost and a downward slope for diminishing value. Which method works best? It depends. The diminishing value method is generally more advantageous for small business owners for the simple reason that a dollar today is worth more than a dollar tomorrow. The prime cost method, however, offers greater consistency – and if you do keep the asset for its life, this method can offer greater reductions in the long term.

Crunching the numbers

In the case of the prime method, you calculate your asset’s cost multiplied by the number of days held out of 365, times 100% of its effective life. For the diminishing value method, start with the base value and multiply by the number of days held out of 365, times 200% out of your asset’s effective life.

If you’re struggling to crunch the numbers, use the ATO’s helpful depreciation and capital allowances calculator, which compares the results of both options.

Exceptions

It’s important to note that the rules change when considering ‘capital works’, which include buildings and structural improvements. Different rules also apply to horticultural plants and water-supply facilities used in primary production, as well as electricity and phone connections, and assets used in mining exploration.

The restraint clause

Whatever business assets are on your wish list, ensure you have sufficient cash flow before going on a shopping spree. It’s might be useful to keep enough cash for a flat-screen display, coffee machine, swivel chair or air-conditioning unit, but never buy an asset simply because it offers a tax advantage.

You should only buy the assets you need to run your business, and remember to keep a record of every purchase. Accounting software like QuickBooks Online can calculate depreciation values and track assets to maximise your return during tax time.

Bottom line

All you need to do is choose your method, and use a depreciation tool if you need a little help with the math. Alternatively, accounting software can guide you through the entire process.

Tax deduction is only one defensive cash flow strategy you can take, so never stop thinking about ways to generate more capital for your business.

To read more articles related to Small Business Tax, visit here.

Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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