The Ultimate Guide on Effective Life of Depreciating Assets in Property

The Ultimate Guide on Depreciation Effective Life of Assets in Property 

You’ve just purchased your first investment property and are looking for ways in which you could reduce your taxable income through tax depreciation. 

Understanding the effective life of your assets is not just a way to maximise tax deductions, but also a smart financial move for your investment property. 

How do you assess the effective life of your assets? And how do you know what rate you can use to depreciate your assets? 

The Australian Tax Office prescribes an asset’s effective life to each asset you may own in your investment property, which is crucial for calculating depreciation deductions under Division 43 of the Income Tax Assessment Act. 

We’ve put together this ultimate guide to provide an overview of how the effective life of depreciating assets is calculated. 

What Is Property Depreciation, Effective Life, & The Implications? 

As a building ages, its structure and assets are subject to general wear and tear. In other words, each year, the asset’s value declines, and thus, it depreciates.  

Understanding an asset’s effective life is crucial for accurately determining its decline in value, and using tailored methods like the effective life method can better reflect the depreciation seen in an asset over time. 

The Australian Tax Office (ATO) allows property investors who generate income from their properties to claim depreciation as a tax deduction. 

There are two types of depreciation deductions 

1.      Division 43 – Capital Works Deductions 

Capital Works Deductions refer to the depreciation of the building’s structure. The structure of a residential building, if constructed after September 1987, generally has an effective life of 40 years. 

This means the depreciation rate is calculated at 2.5% annually for 40 years. The Income Tax Assessment Act 1997 outlines specific rules and methodologies for determining these deductions, impacting how capital works deductions are applied to income-producing assets. 

(b) Division 40 – Plant and Equipment 

“Plant and equipment” refers to the fixtures and fittings within the building. These are generally known as easily removable assets and include items such as: 

• carpets; 

• ovens; 

• blinds; and 
  
• air conditioning units 

The tax regulations for these assets often involve self-assessment of their effective life, similar to the treatment of tangible assets. 
 
For more information on the kinds of deductions you could potentially claim, click here for The Ultimate Guide on Investment Property Tax Deductions. 

What Is the Effective Life of Depreciating Assets? 

The effective life of a depreciating asset is the estimated period it will last before it needs to be replaced. In simpler terms, it’s the number of years an asset can be used to generate income before it becomes too worn out to be useful. 

The effective life of a depreciating asset is how long it can be used to produce income. For property investors, this will include the fixtures and fittings known as “plant and equipment” and “capital works.” 

The effective life of depreciating assets determines the time an asset declines in value—its depreciation—for income tax purposes. When an asset is used to produce exempt income, its effective life also influences the tax deductions related to depreciation. 

Plant and equipment assets found in the property will generally wear out more rapidly than the actual structure of the building. Therefore, the effective life of these depreciating assets is shorter. 

The ATO recognises over 6,000 different assets on which investors can claim depreciation deductions. 

For example, a carpet, subject to a fair amount of wear and tear, has an effective life of eight years. 

However, it’s important to note that in 2017, legislation restricts property investors from claiming depreciation only for plant and equipment assets that they purchased or that were included in the newly built property. 

Moreover, if you live in your investment property while installing new plant and equipment, these will be considered “previously used” assets for tax purposes. 

This means that you won’t be able to claim depreciation deductions. 

How Is the Effective Life of Depreciating Assets Determined? 

The ATO allows you to claim an immediate deduction for the entire cost of assets up to $300 or less. 

Depreciation claims for assets that cost more than $300 must be made over the asset’s effective life as part of tax deductions available to businesses. 

There are two ways in which you can determine the effective life of depreciating assets, namely by: 

• the Commissioner of Taxation (Commissioner); or 

• by self-assessing the asset’s effective life 

The Commissioner of Taxation 

Each financial year, the Commissioner issues a Taxation Ruling, in which he decides on the effective life of several different depreciating assets in various industries. 

The latest Taxation Ruling is published on the ATO’s website. The ‘instant asset write off‘ provision, part of recent government budget measures, impacts this determination by allowing small businesses to immediately deduct the cost of eligible assets, thus influencing the effective life calculations and financial planning. This means that for assets that qualify for the instant asset write off, their effective life may be shorter as the full cost can be immediately deducted. 

Self-Assessment of the Effective Life of Depreciating Assets 

The standard estimate provided by the Commissioner may not always necessarily fit your specific circumstances, so the ATO allows you to work out the effective life yourself in these cases. 

The following factors can be used to determine how many years an asset can reasonably be expected to produce income based on the circumstances in which it’s being used: 

• the manufacturer’s specifications; 

• your own, if any, former experience with the asset or something similar; 

• the estimated physical life of the asset; 

• the level of repairs or maintenance generally recommended by other owners of the assets; 

• Other asset owners’ experience of the asset or something similar; 

• retention periods; and 

• scrapping or abandoning practices. 
   
  The effective life of a depreciating asset should be calculated from the date of its first use or the date that it is installed and ready for use. 
   
  The ATO’s ‘Guide to Depreciating Assets‘ is a valuable resource that provides guidance on how to work out the decline in value of your depreciating assets, ensuring you’re on the right track with your investment property. 
   
  You may find this guide helpful should you opt to self-assess the effective life of the depreciating assets in your investment property. The self-assessment rules also apply to intangible assets, allowing you to determine their effective life for tax purposes based on the same factors. 

Example: 

Christine owns an investment property in Wellington Point, Queensland. 

In May 2019, after two years of owning the property, she decided that it was time to replace all the carpets in the property. 

The total cost of replacing the carpets amounted to $6,120. 

According to the latest Taxation Ruling, carpet has an effective life of eight years. If the depreciation is calculated using the diminishing value method, the rate of depreciation is 25%: 

$6,120 x 25% = $1,530 

In the first full financial year following the carpet installation, Christine can claim $1,530 in depreciation deductions. 

A good way of staying on top of the depreciation process is having a quantity surveyor draw up a depreciation schedule. A depreciation schedule charts an asset’s value loss over its effective life. 

Below is a sample depreciation schedule drawn up by us at Duo Tax: 

This report can be issued to you and your accountant to plan for subsequent years when filing your annual tax return. 

The Income Tax Assessment Act 1997 impacts the calculation of depreciation by outlining the rules governing the effective life of depreciating assets and the methodologies used by the Commissioner of Taxation for making determinations related to depreciation. 

What About Low-Value Pooling? 

If you have any plant and equipment assets that are valued at less than $1,000, the ATO allows you to depreciate those assets using the low-value pooling method. 

Certain low-value assets can be depreciated by putting them into a ‘low-value pool’ and then depreciating them at a set annual rate. 

This will allow you to depreciate any plant and equipment assets at a faster rate so that you can maximise your depreciation deductions. 

Assets within the low-value pool can be depreciated at a rate of 18.75% in the first year and 37.5% each subsequent year. 

As the assets in your property investment age, they decrease in value, a process known as depreciation. 

The benefit of depreciation for property investors, however, is that it allows you to claim the loss in value as a tax deduction. The effective life of depreciating assets determines the asset’s decline in value. 

While the ATO does allow you to self-assess the effective life of your fixtures and fittings, calculating the depreciation and what you can claim could get tricky. This is even more the case if you are dealing with various moving pieces. 

Consulting an experienced tax professional or quantity surveyor would be beneficial in more ways than one. Often, it takes more work to gauge or estimate the initial costs. Not having any expertise in understanding the components that go into certain aspects, particularly with capital works, could mean you miss out on significant tax depreciation opportunities. 

At Duo Tax, our tax depreciation experts are both building and tax experts who can provide you with a depreciation schedule that will not only break down your claimable deductions but will also save you thousands of dollars in tax each year. 

To see how our quantity surveyors can help you, get in touch today!