Working out decline in value

From 1 July 2001, deductions for the decline in value of most depreciating assets, including those acquired before that date, are worked out under the UCA rules.

The UCA contains general rules for working out the decline in value of a depreciating asset and those rules are covered in this part of the guide. (Transitional rules apply to depreciating assets held before 1 July 2001 to enable their decline in value to be worked out using these rules, see Depreciating assets held before 1 July 2001.)

The general rules do not apply to some depreciating assets. For these assets, the UCA provides specific rules for working out deductions:

• there is an immediate deduction for certain depreciating assets which cost $300 or less that are used predominantly to produce assessable income that is not income from carrying on a business – see Immediate deduction for certain depreciating assets costing $300 or less
• the decline in value of certain depreciating assets that cost or are written down to less than $1000 can be worked out through a low-value pool – see Low-value pools
• for in-house software, expenditure allocated for deduction to a software development pool – see Software development pools
• for depreciating assets used in exploration or prospecting, the decline in value is the asset’s cost – see Mining and quarrying and minerals transport
• for the decline in value of certain depreciating assets used in primary production – see Primary production depreciating assets – and for capital expenditure incurred by primary producers and other landholders used in landcare operations, electricity connections or telephone lines – see Capital expenditure of primary producers and other landholders

There are specific rules for working out deductions for depreciating assets used in carrying on research and development activities-see the Research and development tax concession schedule and instructions for more information.

When does a depreciating asset start to decline in value?

The decline in value of a depreciating asset starts when you first use it, or install it ready for use, for any purpose including a private purpose. This is known as a depreciating asset's start time.

Although an asset is treated as declining in value from its start time, a deduction for its decline in value is only allowable to the extent it is used for a taxable purpose. Taxable purpose means for the purpose of producing assessable income. It also means for the purposes of exploration or prospecting and of mining site rehabilitation, and for environmental protection activities.

If you initially use an asset for a non-taxable purpose, such as for private purposes, and in later years use it for a taxable purpose, you need to work out the asset's decline in value from its start time through the years it was used for a private purpose before you can work out your deductions for the decline in value of the asset in the years it is used for a taxable purpose, see Decline in value of depreciating asset used for non-taxable purpose for information about deductions for the decline in value of depreciating assets used partly for non-taxable purposes.

Methods of working out decline in value

As with the depreciation rules, you have the choice of 2 methods to work out the decline in value of a depreciating asset: the prime cost method and the diminishing value method.

You can choose to use either method for each depreciating asset you hold. Once you have chosen a method for a particular asset, you cannot change to the other method for that asset.

In some cases, you do not have to make the choice because you can deduct the asset's cost-for example, certain depreciating assets which cost $300 or less, see Immediate deduction for certain depreciating assets costing $300 or less. In other cases, you do not have a choice of which method you use to work out the decline in value:

• for specified intangible depreciating assets – in-house software, certain items of intellectual property, spectrum licences and datacasting transmitter licences – you must use the prime cost method
• you must use the same method as an associate has used if you acquire a depreciating asset from an associate who has deducted, or can deduct, amounts for the decline in value of the asset – see Depreciating asset acquired from an associate
• you must use the same method the former holder has used if you acquire a depreciating asset but the user of the asset does not change or is an associate of the former user (for example, under sale and leaseback arrangements) – see Holder changes but user same or associate of former user

Both the diminishing value and prime cost methods are based on a depreciating asset's effective life-the rules for working out an asset's effective life are explained in Effective life.

Calculation of the decline in value allows you to determine the adjustable value of a depreciating asset. A depreciating asset's adjustable value at a particular time is its first element and second element of cost (first and second elements) less any decline in value up to that time. Adjustable value is similar to the concept of undeducted cost used in the depreciation rules. The opening adjustable value of an asset for an income year is the same as its adjustable value at the end of the previous income year.

The decline in value and adjustable value of a depreciating asset are calculated from the start time independently of your use of the depreciating asset for a taxable purpose. However, your deduction for the decline in value is reduced to the extent your use of the asset is not for a taxable purpose, see Decline in value of depreciating asset used for non-taxable purpose. Your deduction may also be reduced if the depreciating asset is a leisure facility or boat even though the asset is used, or installed ready for use, for a taxable purpose, see Decline in value of leisure facilities and boats.

The diminishing value method assumes that the decline in value each year is a constant proportion of the remaining value and produces a progressively smaller decline over time. The formula is:

Base value × (days held ÷ 365) × (150% ÷ asset's effective life)

For the income year in which an asset's start time occurs, the base value is the asset's cost. For a later income year, the base value is the asset's opening adjustable value plus any amounts included in the asset's second element of cost for that year.

Days held is the number of days you held an asset in an income year in which you used it or had it installed ready for use for any purpose. If the income year is the one in which the asset's start time occurs, you work out days held from its start time. If a balancing adjustment event occurs for the asset during the income year (for example, if you sell it), you work out days held up until the day the balancing adjustment event occurred-see What happens if you no longer hold or use a depreciating asset? for information on balancing adjustment events.

The prime cost method assumes that the value of a depreciating asset decreases uniformly over its effective life. The formula for the prime cost method is:

Asset's cost × (days held ÷ 365) × (100% ÷ asset's effective life)

An adjusted prime cost formula must be used if:

• you recalculate the effective life of an asset – see Effective life
• an amount is included in the second element of cost of an asset’s cost after the income year in which the asset’s start time occurs
• an asset’s cost or adjustable value is reduced by a debt forgiveness amount – see Commercial debt forgiveness
• there is roll-over relief and the transferor was using the prime cost method – see Roll-over relief
• you must reduce the opening adjustable value of a depreciating asset which is the replacement asset for an asset subject to an involuntary disposal – see Involuntary disposal of a depreciating asset, or
• an asset’s opening adjustable value is modified due to GST increasing or decreasing adjustments or to input tax credits for amounts included in the second element of cost an asset – see GST input tax credits.

The adjusted prime cost formula must be used from an income year in which any of these changes are made (a 'change year'). The formula is:

A × (B ÷ C) × (D ÷ E)

Where:

A is Opening adjustable value for the change year plus any second element of cost for that year

B is days held

C is 365

E is 100%

F is asset's remaining effective life

The asset's remaining effective life is any period of its effective life that is yet to elapse at the start of the change year.

The prime cost formula must also be adjusted for certain intangible depreciating assets you acquire from a former holder, see Effective life of intangible depreciating assets.

Depreciating assets held before 1 July 2001

To work out the decline in value of depreciating assets you held before 1 July 2001, you generally use the same cost, effective life and method that you were using under the former law.

The undeducted cost of the asset at 30 June 2001 becomes its opening adjustable value at 1 July 2001. The undeducted cost of the asset is worked out under the former depreciation rules. It is the asset's cost less the depreciation for the asset up to 30 June 2001, assuming that it was used wholly for producing assessable income.

For a depreciating asset that is an item of intellectual property or a spectrum licence and for certain depreciating assets used in mining, quarrying or minerals transport, the opening adjustable value at 1 July 2001 is the amount of unrecouped expenditure for the asset at 30 June 2001 as these assets do not have an undeducted cost under the former rules.

Special transitional rules apply to plant for which you used accelerated rates of depreciation before 1 July 2001 or could have had you used the plant for producing assessable income. These rules ensure that accelerated rates continue to apply under the UCA, see Accelerated depreciation.

If you have a substituted accounting period for your income year that includes 1 July 2001, you need to work out your deduction in two parts. First, you need to calculate your deductions under the former rules from the beginning of the substituted accounting period to 30 June 2001. You then need to work out the decline in value of the depreciating assets from 1 July 2001 to the end of the substituted accounting period under the new rules. If you use the diminishing value method, your deduction may be less than it would have been had you done only one calculation for the income year under the former rules. In that case, you can increase your deduction by the difference between the two amounts.

Accelerated depreciation

For plant acquired between 27 February 1992 and 11.45 am (by legal time in the ACT) on 21 September 1999, accelerated rates of depreciation and broadbanding were available. The rates were based on effective life adjusted by a loading of 20 per cent and broadbanded into one of seven rate groups. The loading together with the broadbanding produced accelerated rates of deductions for depreciation.

Except for certain small business taxpayers, accelerated rates of depreciation are not available for plant you:

• acquired under a contract entered into after 11.45 a.m. (by legal time in the ACT) on 21 September 1999
• constructed, with construction starting after that time or
• acquired in some other way after that time.

Small business taxpayers could continue to use accelerated rates for plant acquired after that time if they met certain conditions when the plant was first used or installed ready for use. However, accelerated rates of depreciation have now been removed for small business taxpayers for depreciating assets they:

• start to hold under a contract entered into after 30 June 2001
• construct and construction begins after 30 June 2001 or
• start to hold in some other way after 30 June 2001.

If you used accelerated rates of depreciation for an item of plant before 1 July 2001 or could have had you used the plant for producing assessable income, you continue to use accelerated rates to work out the decline in value under the UCA. You replace the effective life component in the formula for working out the decline in value with the rate you are using.

For a list of accelerated rates of depreciation, see Accelerated rates of depreciation.

Decline in value of depreciating asset used for non-taxable purpose

The decline in value and adjustable value of a depreciating asset are calculated from the start time independently of your use of the depreciating asset for a taxable purpose. However, your deduction for the decline in value is reduced to the extent your use of the asset is not for a taxable purpose.

Decline in value of leisure facilities and boats

Your deduction for the decline in value of a depreciating asset may be reduced if the asset is a leisure facility or a boat even though it is used, or installed ready for use, for a taxable purpose. The deduction is reduced to the extent the asset is not integral to your income-producing activities or to the extent its use does not constitute a fringe benefit.

Depreciating asset acquired from an associate

If you acquire plant on or after 9 May 2001 or another depreciating asset on or after 1 July 2001 from an associate, such as a relative or partner, and the associate claimed or can claim deductions for the decline in value of the asset, you must use the same method of working out the decline in value as the associate used.

You must also use the same effective life as the associate used where they used the diminishing value method or an effective life equal to the remaining period of the effective life used by them where they used the prime cost method.

You must recalculate the effective life of the depreciating asset if the asset's cost increases by 10 per cent or more in any income year, including the one in which you start to hold it, see How to recalculate effective life for information about recalculating the effective life of a depreciating asset.

You can require the associate to tell you what method and effective life they used by serving a notice on them within 60 days after you acquire the asset. Penalties can be imposed if the associate intentionally refuses or fails to comply with the notice.

Holder changes but user same or associate of former user

If you become the holder of plant on or after 9 May 2001 or another depreciating asset after 1 July 2001 but the user of the asset does not change or is an associate of the former user. For example, under a sale and leaseback arrangement you must use the same method of working out the decline in value that the former holder used.

You must also use the effective life the former holder used where they used the diminishing value method or the effective life equal to the remaining period of the effective life used by them where they used the prime cost method.

If you cannot readily ascertain the method the former holder used or if they did not use a method, you must use the diminishing value method. An effective life determined by the Commissioner of Taxation must be used if you cannot find out the effective life the former holder used or if they did not use an effective life.

You must recalculate the effective life of the depreciating asset if the asset's cost increases by 10 per cent or more in any income year, including the one in which you start to hold it-see How to recalculate effective life for information about recalculating effective life.