A Simple Guide to Understanding Depreciation

Estimated reading time: 7 minutes

Depreciation allows Australian taxpayers to claim tax deductions for income-producing assets over $300 by spreading the cost over the asset’s effective life. Learn how depreciation works, which method to use, and how to claim it on your tax return

Everything you need to know about claiming depreciation

Let’s take a more detailed look at depreciation, what it is, how it works, how to make sense of the confusing terms and how to claim it on your tax return each year.

What is depreciation?

When you buy items that cost more than $300 for your job, business, or investments, such as fittings and fixtures for a rental property, unless you’re a business, you generally can’t claim the full cost as an immediate tax deduction. Instead, these items are considered capital assets (items used to generate income), so you must depreciate them over time. Depreciation is an asset’s gradual loss in value over time. You claim part of this loss each year over the asset’s effective life. (Note: Items that cost less than $300 can be claimed in full on your tax return, and do not require depreciating).

How does depreciation work?

Okay, to make things very simple, let’s look at depreciation this way:

• If you bought a brand-new washing machine, you might pay $1,000 for it.
• If you sold that same washing machine 4 years later, you wouldn’t expect to still get $1,000 for it. That’s because the value of the washing machine has decreased due to the wear and tear of use over those 4 years.

How to calculate depreciation

There are two main ways to calculate depreciation:

1. Straight line depreciation:
   • This method spreads the annual tax deduction evenly across the asset’s effective life.
   • Formula: (asset cost ÷ effective life)
   • Example: $1,000 washing machine ÷ 8 years = $125 per year
2. Diminishing value method:
   • This method allows for higher deductions in the earlier years and lower value deductions the closer the asset gets to the end of its effective life.
   • Formula: (Base Value x (200% ÷ effective life))
   • Example Year 1: $1,000 washing machine x (200% ÷ 8) = $250
   • Example Year 2: $1,000 – $250 = $750 base value x (200% ÷ 8) = $187.50

Which depreciation formula should you use?

To choose the right depreciation formula, think about how the item is used. If it wears out quickly or sees heavy use early on in its life, diminishing value method often provides larger deductions upfront and may be more tax-effective. This would be a suitable method for a work vehicle, or similar, as the value of the item reduces significantly at the beginning of its life. If the item is used consistently over its life, the straight-line method is usually more suitable, as it spreads deductions evenly across each year.

Don’t worry though, ask your accountant, and they’ll recommend the best method for each asset you claim.

What is the effective life of depreciating assets?

We’ve talked about effective life, but what exactly does that mean? The effective life of an asset is the amount of time the item is expected to be fit for purpose. You can review the ATO’s guidelines to determine the effective life of common assets and your tax agent will also be able to work this out for you.

For example: A mobile phone is considered by the ATO as having an effective life of 3 years. The amount of use the phone would have, is likely to remain the same throughout that time, or over its life. So it would make sense to claim the cost of the phone over the 3 years, using the straight-line method.

What Can You Claim Depreciation On?

Depreciation applies to many types of work, business and investment-related purchases over $300.

You can claim depreciation on things like:

• Office equipment (computers, printers, phones)
• Tools and machinery
• Work vehicles (subject to limitations such as the car limit threshold and luxury car tax rules)
• Desks, shelves, and other furniture

Rental Property Depreciation

• Rental property fixtures, fittings and equipment, like carpets, blinds, and appliances
• Rental property Capital Works (such as an extension or a new kitchen), plus plant and equipment (such as ovens or air conditioners).

Keep in mind two key rules:

• Personal items or assets for personal use only, cannot be depreciated.
• If you use an asset for work and personal use, you must apportion it first and only claim the work-related value, not the full purchase price. For example, if you use an item 60% for work and 40% for personal use, and it cost $2,000 with a 2 year effective life you would claim: $2000 x 60% ÷ 2 years = $600 per year.

Depreciation Schedule

When you rent out your property, it’s important to engage a surveyor to prepare a Depreciation Schedule, also known as a Quantity Surveyor’s Report.

This report outlines the depreciation rates for the building itself as well as the fixtures, fittings and appliances each year. Without it, it’s likely that you are leaving valuable deductions on the table that could significantly boost your tax refund each year. The bonus is, the cost of the Depreciation Schedule is also tax deductible!

What Records Do I Need To Claim Depreciation

Make sure you keep a record of every expense you’re planning to claim. This is particularly important when you are claiming for renovations to your rental property or when claiming depreciation on multiple work- or business-related items.

Include The Following In Your Record Keeping:

1. What the item is.
2. The date you purchased it and the date it was first used.
3. The cost of installation/set up.
4. How much you use the asset for personal activities, as a percentage (apportionment).
5. Effective life.
6. Claim method.

Tip: If you’re ever unsure about anything to do with depreciation claims, your tax agent can help you. They can work out which claim method is most beneficial to you, the effective lifespan of each asset and how much you can claim each year.

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Investments and Expenses

Further reading:

• Etax Property Investment Tax Hub
• Investment property tax deductions under the ATO spotlight
• Holiday Rental Tax Deductions: The Basics
• Rental Property Tax Deductions – made easy!
• Capital gains tax: Does it apply to you?