The plant and equipment depreciation rate can be complex to navigate. This powerful—yet often overlooked tool—can be a weapon for savvy investors. Tax deductions such as this can substantially improve an investor’s bottom line; however, many fail to take full advantage of them.
It often boils down to a lack of understanding about depreciation, how it works, and, most importantly, how to claim it. This article will clear up the confusion around one specific type of depreciation: plant and equipment depreciation.
What is Property Depreciation?
Property depreciation is the gradual reduction in the value of a property’s building structure and assets over time due to factors such as wear and tear, aging, or becoming outdated.
Investors can claim depreciation as a tax deduction, which offers a significant benefit by lowering their taxable income. This is why it’s such an important concept to grasp.
Knowing how to claim property tax depreciation can lead to substantial savings, making it a valuable strategy for optimising investment returns.
The Australian Taxation Office (ATO) splits property depreciation into two distinct categories:
- Division 43
- Division 40
Division 43: Capital Works Allowance
Division 43, known as the Capital Works Allowance, pertains to the property’s building structure and any permanent fixtures. This includes elements such as the building’s walls, roof, windows, doors, and built-in kitchen or bathroom units.
These items typically depreciate at a rate of 2.5% per year over 40 years, starting from when the construction was completed. It’s worth noting that this applies only to properties constructed after July 1985.
Division 40: Plant and Equipment
Division 40 refers to Plant and Equipment. This category includes removable or mechanical assets within the property, such as appliances (e.g., dishwashers and ovens), carpets, blinds, air conditioning systems, and furniture in a furnished property.
The ATO sets varying depreciation rates for these items based on the asset’s effective life.
ATO Depreciation Methods in Australia
The ATO uses these two methods to calculate depreciation:
- Prime cost method
- Diminishing value method
Prime Cost Method
The prime cost method assumes that the value of a depreciating asset decreases uniformly over its effective life. It’s a straightforward approach where the immediate deduction for each year is calculated as a percentage of the cost.
Diminishing Value Method
The diminishing value method assumes that the value of a depreciating asset decreases more in the early years of its effective life. Therefore, the deductions are higher in the earlier years and decrease over time.
The choice between these methods depends on your strategy and cash flow needs.
How to Determine the Effective Life and Depreciation Rates of Plant and Equipment
The effective life of an asset is an estimate of the time (in years) that a depreciable asset can be used for income-producing purposes. The ATO provides guidelines on the effective life of various assets, which can be used to calculate their depreciation rates.
The depreciation rate for plant and equipment assets is determined based on their effective life.
For example, according to the Commissioner’s guide, a dishwasher might have an effective life of 10 years, while a carpet might be expected to last 8 years. This means that, under the prime cost method of depreciation, a dishwasher worth $1000 would depreciate at a rate of $100 per year over its effective life.
The Commissioner’s Role in Plant and Depreciation Equipment Rates
The Commissioner of Taxation determines the effective life and depreciation rates for plant and equipment assets. They are responsible for providing the estimates of effective life for many assets commonly used in various industries. These are published annually in the ATO’s “Effective Life” rulings.
The estimates are based on extensive research and consultation with industry experts, manufacturers and other stakeholders. They consider the quality of the asset, usage patterns and the conditions in which the asset will be used.
Can You Determine Your Own Effective Life Estimates?
While the Commissioner’s estimates are a good starting point for calculating depreciation, they are not binding. Taxpayers can self-assess the effective life of an asset based on their own circumstances. However, all of it must be justified and supported by evidence.
It’s worth noting that the Commissioner’s effective life determinations are updated regularly to reflect changes in technology, manufacturing processes, and industry practices. Investors and tax professionals to stay current with the latest rulings and guidelines.
Depreciation Rules for Second-Hand Assets
It’s important to note that the rules around claiming depreciation on second-hand assets have changed in recent years.
As of May 9, 2017, investors who purchase second-hand residential properties can no longer claim depreciation on existing plant and equipment assets.
However, this rule doesn’t apply to the following :
- Brand new properties
- Substantially renovated properties
- Properties purchased before May 9, 2017
- Any new or newly installed items purchased for the property
If you fall into one of these categories, you can still claim depreciation on the relevant plant and equipment assets.
Claiming a Depreciation Schedule On Plant and Equipment
Investors will need a tax depreciation schedule to claim depreciation on plant and equipment in your residential investment property, which we can prepare. This comprehensive report outlines all the depreciating assets within your property and how much they depreciate each year.
A depreciation schedule is essential for maximising your tax deductions and ensuring compliance with the regulations. It provides a clear record of your property’s depreciable assets and respective depreciation rates, making it easier to claim deductions each tax year.
Contact us if you need a quote or have any questions regarding tax depreciation.
Key Takeaways
- Property depreciation is a tax deduction that allows investors to claim the gradual reduction in the value of a property’s building structure and assets over time.
- Property depreciation is split into two categories: Division 43 (Capital Works Allowance) and Division 40 (Plant and Equipment).
- Depreciation rates for plant and equipment assets are based on their effective life, which can be estimated using the Commissioner’s guide or your own justified estimates.
- Depending on your strategy and cash flow needs, depreciation can be calculated using either the prime cost method or the diminishing value method.
- A tax depreciation schedule prepared by a qualified quantity surveyor is essential for claiming depreciation deductions and ensuring compliance with the regulations.
- As of May 9, 2017, depreciation cannot be claimed on existing plant and equipment assets in second-hand residential properties, with some exceptions.
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Tuan is an award winning Quantity Surveyor and leads Duo Tax Quantity Surveyors – Australia’s fastest growing provider of Tax Depreciation.
