What is the straight-line method of depreciation?

BMT team — Wed, 01 Sep 2021 06:17:19 +0000

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.

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Selecting the best method for you

BMT team — Mon, 25 Jul 2016 01:20:54 +0000

An individual’s strategy is just as important a factor to consider when claiming the deductions available from an investment property as it is to obtain a comprehensive depreciation schedule outlining all of the depreciation that can be claimed. While many investors fail to maximise depreciation deductions for their investment property, those who do obtain a schedule aren’t always aware that they can choose between two different methods when claiming depreciation for the plant and equipment assets found within the property. A specialist Quantity Surveyor will use two methods to outline the deductions that can be claimed in a depreciation schedule as explained below. Prime cost method Under this method, the depreciation deduction for each year is calculated as a percentage of the cost. A simple way to explain the outcome of this method is that deductions will occur in a relatively straight line. Basically, this means an investor will receive more constant deductions throughout the life of the property. Diminishing value method Under the diminishing value method, the deduction is calculated as a percentage of the balance you have left to deduct. By selecting this method, an investor’s deductions for plant and equipment assets will be higher in the earlier years of owning the property and depreciate over time. The following comparison graph shows an example of the deductions for assets over the first ten years using both of two methods. When an investor first contacts a Quantity Surveyor to ask for a depreciation schedule, it is important to ask whether a schedule will incorporate both methods in the final report received. Once the schedule has been prepared and received, the next step an investor should take is to seek advice from an Accountant or a tax professional on which method will suit their individual investment strategy. This step is important as a property investor can only choose one method to claim depreciation deductions for assets. Once they have made their selection, they may not be able to change their method for the assets which they have claimed deductions for in previous years. A simple guide to help investors choose between the two methods is to explain that those who only plan on holding a property for a relatively short period of time, those wish to build their investment portfolio quickly or those who might want to save to budget for a renovation may prefer the diminishing value method. Alternatively, those who might prefer to claim deductions so they receive them at a more constant rate over a longer period of time may choose the prime cost method of depreciation. When obtaining a depreciation schedule for any investment property purchase, it is important to ask questions to understand the difference that depreciation deductions will have on your individual scenario. Depreciation deductions can have a significant impact on your cash flow, both immediately and in the future. It is therefore important to think about how any additional money received can be incorporated into your budget as this will help you to achieve your investment strategy and ensure that the decision to purchase a property is the most prosperous one.

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What is the straight-line method of depreciation?

Selecting the best method for you