Tax depreciation is a complex topic, with different factors contributing to how and when it can be claimed.
The straight-line method of depreciation is just one approach to claiming depreciation. But what is it and how does it maximise cash?
What is depreciation?
Before we start talking about the straight-line method, let’s first explore depreciation.
Property and assets experience natural wear and tear over their lifetimes – they depreciate. Owners of income-producing properties can claim this depreciation on eligible assets each financial year as a tax deduction.
Depreciation can be claimed on either capital works or plant and equipment assets. Capital works is claimed on the structure of the building and fixed assets like door handles, windows, fences and built-in cupboards. Plant and equipment assets are those that are easily removable or mechanical in nature such as furniture, air-conditioning units, window coverings and light fittings.
Depreciation works like any other tax deduction. It reduces an investor’s income, so they pay less tax. But the major perk is that unlike any other investment property tax deductions, no money needs to be spent to claim depreciation.
What is the straight-line method of depreciation?
So, how much depreciation can be claimed? This depends on the asset type, value and the method of depreciation that is chosen.
Capital works depreciate at a set rate of 2.5 per cent over forty years. For example, a built-in wardrobe valued at $2,600 would produce a full year depreciation deduction of $65.
It works differently for plant and equipment assets. Every plant and equipment asset has its own effective life, which determines the rate it depreciates using one of two methods.
The first is the diminishing value method, and the second is the prime cost method – also known as the ‘straight-line method’ of depreciation.
The diminishing value method calculates deductions as a percentage of the asset’s depreciable balance. This means deductions are higher in earlier years.
The prime cost method calculates deductions each year as a percentage of the asset’s cost. The result is that deductions are spread out over time with a more even claim each financial year, forming a straight line over time.
The equation for the prime cost (straight line) method, as defined by the Australian Taxation Office, is as follows:
Asset’s cost × (days held ÷ 365) × (100% ÷ asset’s effective life)
For example, carpet has an effective life of eight years resulting in a prime cost depreciation rate of 12.5 per cent. This means carpet valued at $5,000 would produce a full financial year depreciation deduction of $625.
Below are visual representations of the straight-line method applied to carpet depreciation.
Who should consider using the straight-line method of depreciation?
Investors can choose to depreciate a plant and equipment asset using either the diminishing value or prime cost (straight line) method. Once a method is chosen for an asset, it can’t be changed.
The vast majority of investors choose the diminishing value method of depreciation as it results in higher deductions in earlier years.
However, the choice should always come down to an investor’s investment strategy. For example, the prime cost method may be more suitable for a long-term investment strategy as it produces consistent deduction each financial year.
Who can assist when deciding which method of depreciation to use?
The depreciation experts at BMT Tax Depreciation know how to correctly apply all methods of depreciation.
A BMT Tax Depreciation Schedule shows the deductions available using both diminishing value and prime cost (straight line) methods of depreciation. This way an investor can go over their schedule with their accountant to help determine the best method to use for their plant and equipment assets.
To learn more about depreciation and how a BMT Tax Depreciation Schedule can ensure you choose the best method for your investment strategy, Request a Quote or contact the team on 1300 728 726.