Depreciation is an allocation mechanism for spreading the initial cost of an asset across each of the income years that asset is used by the taxpayer to earn assessable income.
Only depreciable properties may be depreciated. Normally they are expected to decline in value while used in deriving assessable income (EE6(1)).
Non-depreciable property (EE7)
The below properties are not depreciable:
- Building (Useful life over 50 years)
- Trading stock
- Livestock used in dealing business and covered by the trading stock rules
- Financial arrangements
- Property that will not decline in value
- Property that the owner chooses to treat as not depreciable
- Property that the owner chooses to treat as low-value property
- Properties where the cost is deductible to a person other than the owner. This means you don't actually own the property.
- Assets used in deriving employment income; privately used assets
Employees are unable to claim deductions for any depreciation related to assets used to deriving employment income or used for private purpose.
If an asset is partly used for deriving business income, depreciation can be claimed on the usage that related to deriving business income.
- Items of low value
A taxpayer may deduct the full cost of an item of low value (less than $500) in the income year it is acquired (EE38), provided: they are not purchased from the same supplier at the same time as other assets to which the same depreciation rate applies (unless the entire purchase costs $500 or less).
If a taxpayer disposes an item of low value, the amount received from disposal is depreciation recovery income.
Depreciation of building
Buildings with an estimated life of 50 years or more cannot be depreciated since 1 April 2011.
A taxpayer who claimed a depreciation deduction on a zero depreciation rate building is still subject to depreciation recovery income if he sold the building for more than tax book value.
Base value of property converted to a business use
Generally, the base value of an asset is its cost, but for property that was firstly acquired for non-business purpose and later used for business purpose, the base value is its market value at the time the property was used for business purpose (EE58).
Base value is GST-exclusive if the taxpayer is GST-registered; otherwise it is GST-inclusive.
Adjustment on disposal
No depreciation deduction is allowed in the income year when an item of depreciable property is disposed of.
If a depreciable asset is sold for more than its book value, the depreciation recovery income is taxable, but the amount exceeds accumulated depreciation is capital gain, which is tax free.
If a depreciable asset is sold for less than its book value, the loss is deductible.
Example: A car was bought at a cost of $10,000. The adjusted tax value at the start of income year is $4,000, and it has an accumulated depreciation of $6,000. If the car was sold for $8,000, the 8000-4000=$4,000 is depreciation recovery income. If the car was sold for $12,000, the depreciation recovery income is 10000-4000=$6,000 , the capital gain is 12000-10000=$2,000 .
Depreciation Calculation Methods
- Diminishing value method (EE67)
The diminishing value method calculates depreciation by subtracting in each income year a constant percentage of an item’s adjusted tax value from its adjusted tax value
Straight-line method (EE67) The straight-line method calculates depreciation by subtracting a constant percentage of an item’s cost from the item’s adjusted tax value. A fixed-life intangible asset can only be depreciated using ST method.
The pooling method enables a group of assets to be depreciated as a single asset. Assets may only be pooled if their cost is below a certain threshold.
The maximum pooling value is normally $5,000 (EE12(2)(C)), but taxpayers can apply for a higher threshold.
A pool asset must be depreciated using diminishing method.
Formula: Rate*((Starting adjust tax value+ Ending adjust tax value)/2)
10%(Using the lowest rate in pool)
- Choice of Method
Taxpayers can choose whatever depreciation methods as long as it is not prohibited by law. There is no requirement to using same depreciation method for all assets either.
Taxpayers can also change depreciation methods but it will not create any tax benefit because depreciation is based on last year’s remaining value.
Depreciation rates are generally based on the expected useful life of an asset. For example, if an asset is going to last for 5 years, then it would be depreciated on a 20% year basis using the straight line method. IRD has published the IRD rates on their website depending on their classification of an asset. These rates are categorised by industry or per asset class.
1) Depreciation rate for new assets:
Assets acquired after 1 April 2005 are classified as ‘new assets’, the rate of depreciation applied to these is calculated in accordance with EE27. These depreciation rates are calculated using double declining balance method and therefore provide a higher rate than the old rates. In order to adjust this difference, a 20% loading is applied to qualifying assets acquired before 20 May 2010.
Double declining method is applied to new assets except (EE27):
- Fixed-life intangible property
- Excluded depreciable property;
- Aircraft (not including international aircraft)
- Assets with high residential value
- Plant and equipment purchased before 1 April 2005;
- Most motor vehicles
2) Depreciation for Old Assets
Asserts acquired after 1 April 1993 and before 20 May 2010 are classified as ‘old assets’. The rate is increased by 20% known as a ‘loading’.
3) Depreciation rate for buildings:
Buildings purchased before 19 May 2005 is treated the same as old assets.
The depreciation for buildings purchased between 19 May 2005 to 31 March 2011 is calculated using the rate given in the formula: 1/estimated useful life (in years).
Buildings purchased from 1 April 2011 have a depreciation rate of 0%, if the estimated useful life is of 50 years or more. If estimated useful life is less than 50 years, new assets depreciation rates are applied.
4) Depreciation for aircraft and motor vehicles (EE29)
Generally, the economic rate for a motor vehicle that is designed exclusively or mainly to carry persons and has seats for no more than 12 persons is a diminishing value rate of 30% or a straight-line rate of 21%.
The general economic rate for an aircraft is a diminishing value rate of 10% or a straight-line rate of 7%.
5) Fixed life intangible property
Fixed life intangible property is depreciable intangible property that has a legal life that could be reasonably expected, at the date of acquisition, to be the same length as the property’s remaining estimated useful life (EE62, EE67).
The annual depreciation rate is calculated using the formula: 1/legal life. The rate is expressed as a decimal rounded to two decimal places (EE33).
Legal life is the item’s remaining legal life of the property when it was acquired by the taxpayer. If the taxpayer incurs additional costs in relation to the item (e.g., renewal of software), the legal life will be the item’s remaining life from the start of the income year in which the additional costs are incurred.
The cost of software must be capitalised and depreciated at 40% DV or 30% SL. If the cost is less than $500, it can be immediately written off. The cost of maintenance is fully deductible in the year it is incurred, but the cost of upgrades must be capitalised and depreciated at the same rate.
7) Special and Provisional rates
A taxpayer can apply to IRD for a special rate if the annual rate for an asset is too high or too low.
If a taxpayer cannot find a rate for his asset in IRD’s document IR265, they can apply for a provisional rate for his asset.