What is asset depreciation?
Asset depreciation is the decline in value of an asset. The asset must be purchased and used for the purpose of gaining assessable income. As the cost of the asset depreciates over its effective life, the allocation of depreciating amount is considered an expense and therefore a valid tax deduction.
Why is it important?
Although calculating and correctly reporting depreciation assets can be a little tricky and time-consuming, at the end of the day, reducing your taxable income by utilising this deduction is worth the hassle as it means more money in your pocket. Many Australians usually leave the onus of calculating their depreciation amounts to their tax agent.
The list of physical and intangible assets you can include in your choice of depreciable assets is wide-ranging yet includes the majority of items where the assets’ cost or value is measurable and the useful life of the asset will eventually cease. Examples of physical and intangible assets may include but are not limited to:
- Office equipment
- Plants and equipment
- Machinery and electrical tools
- Computer software
Working out the total depreciation cost of the asset will include things like shipping and delivery costs, installation costs, repairs or necessary maintenance before the asset is first used. The value of the assets beings to depreciate only when first used.
If the asset is used for private and domestic use, you will need to calculate the percentage of depreciative amount and claim that portion of use as an expense. For example, if you purchase a car and use 50% for work purposes and 50% for private domestic use, you may only claim half the depreciation cost of the car.
Calculating the depreciating amount
Some items can be written off immediately. This includes items up to $300 used to earn income such as equipment used to perform your job.
There are a couple of methods to calculate the decline in value or cost of an asset outside of these thresholds. The Diminishing Value Method and The Prime Cost Method.
The diminishing value method calculates depreciation by assuming the decline in value is a consistent percentage of the initial cost each year. This would consequently produce a systematically lesser decline in the value of the item over time.
Formula: Initial cost of asset x (days owned/365) x (2 x % of effective life)
The Prime cost method calculates depreciation by assuming the decline in value decreases consistently over its effective life. This would produce a consistent decline from start of effective life to cease of life.
Formula: Cost of asset x (days owned/365) x (% of effective life)
If you are unsure of which method is best suited, there is a handy tool on the ATO website which will assist in deciding which method to use.
By Australian law, you will need to obtain five years’ worth of records for the ATO for auditing purposes if necessary. It is always a good idea to keep an abundance of records as opposed to not enough. You could find yourself in hot water if you are caught without the essential records to prove your claims.
Still a little confused about calculating the cost of your depreciating assets? We can help! The team at Online Tax Return are here to help you maximise your return and make lodging your return a seamless, breezy experience. Contact our friendly team today!