Tax depreciation myths debunked
Tax Alert - May 2015
By Iain Bradley and Veronica Harley
There are some particular quirks and rules that apply when it comes to claiming a tax depreciation deduction. In this article we take a look at some of the common myths that prevail and tax rules that apply in this area.
Myth #1 – All depreciable assets with a cost of $500 or less can be written off immediately
Not necessarily. It is true that assets with a cost of $500 or less (low value assets) can be written off; however there is an exception where a number of low value assets are acquired at the same time from the same supplier and which have the same depreciation rate. Under the single supplier rule, if the total cost of the low value assets purchased as a group is greater than $500, an immediate write-off cannot be taken and the assets must be depreciated.
Myth #2 – I need to own the asset before I can claim tax depreciation
This is generally correct, although the meaning of “own” is extended beyond the ordinary meaning in certain cases. For example a lessee is deemed to own and is able to claim depreciation on the cost incurred by the lessee on leasehold improvements for tax depreciation purposes. Taxpayers should note that there are a number of conditions that must be met for leasehold improvements to be able to be depreciated for tax purposes. Depreciable property subject to finance leases is deemed to be owned by the lessee and as such the lessee can claim tax depreciation on that finance lease asset.
Myth #3 – I can start to claim tax depreciation on an asset from the purchase date
This statement gives rise to two points. The first is that ownership of the asset is not enough. In order to claim depreciation on an item, it must also be used or available for use in deriving assessable income or in carrying on a business to derive assessable income. Therefore tax depreciation can only be claimed from the point a business has commenced and those assets are used or available for use in that business. If an asset is constructed in-house, depreciation can’t be claimed until the asset is able to be used.
The other point to note here is that tax depreciation is calculated on a monthly basis. Therefore if an asset is purchased on 31 March being the last day of the tax year, one whole month’s depreciation can be claimed. This is because tax depreciation is claimed on a monthly, not daily basis.
Myth #4 – If I forget to claim depreciation in one year, I can claim it in the next
It’s not always that simple unfortunately. The base rule is that an item is deemed to have been depreciated even if a taxpayer neglects to claim a tax depreciation deduction in their tax return. This means the opening balance in the following year is the closing tax adjusted value of the asset as if tax depreciation had been claimed. In this case a taxpayer has the following options.
- If a taxpayer wishes to claim a deduction for tax depreciation missed in the prior year’s return, then it can be picked up in the current tax return only if the tax effect of the error is $500 or less.
- If the tax effect of the omitted depreciation claim is greater than $500, then the taxpayer can request that the Commissioner amend the prior year’s tax return using section 113 of the Tax Administration Act 1994.
- Finally, a taxpayer may decide not to claim the omitted depreciation and simply start to claim depreciation from the current year on the corrected adjusted tax book value.
Which option is appropriate will depend on the quantum of omitted depreciation and any compliance costs involved. We acknowledge that some taxpayers may have adopted a pragmatic approach to dealing with issue historically but it is important to be aware of what the technically correct options are.
Myth #5 – I should always claim depreciation
Most people do claim tax depreciation in order to legally maximise available deductions and reduce tax payable. However a taxpayer may not wish to claim depreciation in order to provide relief from depreciation recovery income on the eventual sale or deemed disposal of the property. For example, a person may decide to move overseas and rent out their house. While depreciation can’t be claimed on the building itself any longer, it could be claimed on the chattels within, for example heat pumps, appliances, blinds, carpets and so forth. It would be necessary to establish a base value of the chattels for this purpose which would generally be market value on the date the person starts to use it for rental purposes. However if that property should revert back to private use or is subsequently sold, depreciation recovery income would arise if the sales proceeds exceed the adjusted tax values of the relevant assets to the extent of the depreciation claimed. There is also quite a lot of compliance involved in a scenario like this, and so some taxpayers may choose to elect that those chattels not be depreciated from the outset. If a taxpayer does not wish to claim depreciation on an asset, the taxpayer must state this in writing and attach it to the relevant tax return.
Myth #6 – I can pick and choose the best tax depreciation rate for my asset
Incorrect! In a recent statement, the Commissioner makes it clear that the Income Tax Act 2007 contemplates only one depreciation rate applying to an item and it is therefore a matter of correctly identifying the item and then matching it to the description in the depreciation rate tables that most accurately describes the item. There is a process that should be followed to identify the correct tax depreciation rate.
Myth #7 – If the Commissioner of Inland Revenue issues a new depreciation rate for an item, I don’t have to use it
This depends. Several times a year, the Commissioner will insert new asset classes and determine a depreciation rate which will apply prospectively. This mostly occurs for new types of assets. For example, in recent years the Commissioner has added new asset classes for tablets, smart phones, iPods, remote controllers, surveillance gear, gas detectors and shearing sheds. It may be that taxpayers had been using a default rate in lieu of any specific rate. Taxpayers are actually required to commence using the new rate from the beginning of the income year specified in the determination if the new rate is higher. However if the new rate is lower, a savings provision operates so that the taxpayer can continue to use the higher rate as long as the previous rate was a valid choice at the time. We doubt many taxpayers go back and review whether rates could be increased in light of any new determinations issued.
Myth #8 – Tax depreciation is not claimable on any building
Buildings are depreciable assets; however since the 2012 income year, buildings with an estimated useful life of 50 years or more are statutorily depreciated at the rate of 0%. Buildings with an estimated useful life of less than 50 years can still be depreciated. Admittedly there are not many in this category – but it does include barns, portable buildings, fowl houses, hothouses, pighouses, portable huts and shade houses. Further, certain structures which are “grandparented structures” such as barns, car parks, chemical works, fertiliser works, powder drying buildings and site huts which were owned on or before 30 July 2009 can continue to be depreciated at their pre-30 July 2009 depreciation rates.
Myth #9 – There is no depreciation recovered in relation to buildings because they are not depreciable
Depreciation recovery income will arise on the disposal of any asset where the consideration received is greater than the closing adjusted tax value of the asset to the extent of any tax depreciation previously claimed. Therefore if a building with a useful life of 50 years or more is sold today for greater than tax book value, any depreciation claimed prior to the 2012 income year would still be recoverable.
Myth #10 – Intangible assets are not depreciable
Intangible assets that meet certain criteria are depreciable for tax purposes. Common examples include the right to use software, the right to use a trademark, plant variety rights, the right to use a copyright, patents and the right to use a patent, the right to use land (i.e. a licence), the right to use plant and machinery and the right to use a design, model, plan, secret formula or process. The depreciation rate and method for this type of property is largely driven by the type of property and whether it has a finite life or not.
This is by no means a complete list of the common misconceptions that can arise in relation to depreciation. It can be worthwhile to carry out a periodic review of tax depreciation as it can show up opportunities to make tax savings which can more than pay for any cost involved.
If you would like more information about claiming tax depreciation, please call your usual Deloitte advisor.