A Simple Guide to Understanding Depreciation

How does depreciation work on your tax return

Just the idea of depreciation seems complicated, but understanding it is crucial for those who own rental properties, run a small business or those who want to claim a tax deduction for work-related purchases over $300.

For this reason, we’ve put together a very simple guide to depreciation, to help save money on your taxes now, and in the years to come.

Read on as we cover what depreciation is and how it impacts your tax deductions over time.

First things first: What is depreciation?

Okay, to keeps things very basic, 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.
• With that in mind, it would now only be worth around $500. (More on how we got to that figure in a minute.)

This is the simplest way to look at depreciation: The reduction of an asset’s value over time.

How to calculate depreciation

The ATO has listed the useful or ‘effective’ life of all assets that can be depreciated for tax purposes. The effective life refers to the number of years the asset is expected to work (tools, appliances, laptops etc.) or be fit for purpose, (travel bags, carpets, office furniture etc.).

For example: A new $1000 washing machine for a rental property is considered to have a useful life of 8 years, which is why after 4 years (or halfway through it’s useful life), it’s value would have depreciated by 50% to $500.

ATO depreciation rates for a few other common purchases:

• Mobile phone – 3 years
• Digital camera – 5 years
• Electric hand tools (drills etc.) – 5 years
• Printer – 5 years

Etax Tip: If you use Etax you don’t actually need to calculate depreciation yourself! Simply enter the cost, purchase date, percentage of work-related use and the receipt details into your Etax tax return and we’ll work it out for you.

How does depreciation work?

Items you purchase for work, your investment property or your business can be claimed as a tax deduction. However, any item that costs more than $300 isn’t claimed in full straight away. Instead, you claim it over the effective life of the item. This means you claim the deduction across multiple tax returns.

So, going back to our washing machine, rather than claim the $1,000 on your next tax return, you claim the washing machine over an 8-year period which is its effective life.

Which depreciation formula should you use?

While you don’t need to know these formulas if you use Etax, we’ll cover them below for anyone who wants to understand the maths behind depreciation calculations.

1. The Prime Cost method: (Also referred to as ‘straight line depreciation’.)

This method works on the assumption that the value of an asset declines steadily over its effective lifespan.

To calculate depreciation using the prime cost method, you need to divide the original cost of the asset by its effective lifespan. This will give you an annual amount

2. The Diminishing Value method

This method assumes the value of the asset will decrease faster earlier in its effective lifespan. This method is often favoured as it gives a better tax deduction in the early years of owning the asset.

What can you claim depreciation on?

Rental Properties

If you own a rental property, depreciation is a good way to minimise your tax liability.
There are two main types of depreciation you can claim on property:

1. Capital Works: The building’s structure and any permanent fixtures, such as the walls, roof and floor. You claim capital works depreciation on properties built from 16 September 1987 onwards, at a rate of 2.5% per year, for 40 years.
2. Plant and Equipment: The non-structural items within the building, such as dishwashers, water heaters, washing machines, air conditioners, carpets, and blinds. The depreciation rates vary on these items, depending on their effective life.

Depreciation Schedule (Quantity Surveyors Report):

What is it and do you need one? If you own an investment property, you should get a surveyor to create a Depreciation Schedule – sometimes referred to as a Quantity Surveyors Report – before you start renting it out. It details the tax deductions you can claim over time on the property itself, as well as the appliances and equipment within it. Without the report, you could miss out on valuable deductions that can offset your rental income over a good number of years. The good news is, the cost of the tax depreciation schedule is also tax deductible!

Work-related expenses

Depreciation is an important aspect of work-related tax deduction claims. If you purchase tools or equipment for work that cost more than $300, such as a laptop, phone or power tools, you can claim depreciation on these items on your tax return each year. Many common work-related purchases have a relatively short lifespan. So, if you bought a laptop for work at a cost of $1500, you claim the cost of the laptop over the life of the laptop, which is only 2 years.

Note: If you use a work-related asset, like a laptop for personal use as well as work use, you must only claim the work-related percentage. So, if you used the laptop for work 50% of the time and for personal use 50% of the time, you should only claim the depreciation on $750. Not the full $1,500 purchase cost.

Business expenses

When you’re in business, especially when you’re first setting out, expenses for equipment, appliances, tools, office furniture and even vehicles are essential costs. However, it’s not easy to see that money disappear, so claiming depreciation on the assets you bring into the business is a great help when it comes to tax time.

For now, there is some good news for sole traders and small businesses, as far as depreciation is concerned:

Temporary Changes: Instant Asset Write Off: 2023-2025

As part of the Governments simplified depreciation rules, the ‘Instant Asset Write-Off’, allows small businesses and sole traders with an aggregated turnover of less than $10 Million, to claim the full cost of eligible assets, up to $20,000, that would normally need to be depreciated. Purchased assets can be claimed as a tax deduction, the year they were paid for. This reduces your taxable income by the total cost of the asset right away, rather than depreciating it over several years. The rules and limits for the write-off have changed regularly since the simpler depreciation rules were bought in for businesses. As such, it’s important to check latest legislation regularly – or ask your Etax Accountant.

Further reading:

• https://www.ato.gov.au/businesses-and-organisations/income-deductions-and-concessions/depreciation-and-capital-expenses-and-allowances/simpler-depreciation-for-small-business
• https://www.ato.gov.au/businesses-and-organisations/income-deductions-and-concessions/depreciation-and-capital-expenses-and-allowances/simpler-depreciation-for-small-business/instant-asset-write-off

 

Record keeping

As with anything to do with tax, it’s important that you keep a record of everything you purchase. You should keep records for 5 years from the purchase date of each item you wish to claim depreciation on.

You’ll need a record of:

• What the item is
• Date of purchase
• Date of first use
• Effective life
• Cost (including installation or set up fees)
• Percentage of personal use
• Chosen claim method (Prime Cost/Straight Line or Diminishing Value)

Final note:

Depreciation is a great way to reduce your taxable income and boost your tax refund. At Etax, we look after the complicated part so you don’t have to. So don’t be afraid to claim back what’s yours when it comes to depreciating assets.