Depreciation is a tax deductible allowance for the reduction in value of certain depreciable fixed assets (such as motor vehicles, plant, equipment) due to the normal wear and tear or obsolescence.
The rate of depreciation is determined by the IRD – www.ird.govt.nz/calculators/keyword/depreciation/calculator-depreciation-rate-finder.html.
Depreciation does not apply to intangible assets such as goodwill, however some intangible assets may be amortised for tax purposes under the fixed life intangible property rules.
There are two methods of applying depreciation; one is the straight line method, and the other is the diminishing value method.
The straight line method allocates depreciation at a rate calculated on the original cost of the asset. The diminishing value method uses the cost less accumulated depreciation as the amount depreciation is calculated on.
- A fixed asset costs $100 and has a depreciation rate of 10% straight line. The allowable depreciation for tax purposes is $100 x 10% = $10.00 each year.
- A fixed asset costs $100 and has a depreciation rate of 20% diminishing value. The allowable depreciation for tax purposes is $100 x 20% = $20.00 in year one, ($100 – $20) x 20% = $16.00 in year two, ($100 – $20 – $16) x 20% = $12.80 in year three, and so on.
Where a fixed asset is bought partway through a financial year, depreciation is calculated for the number of months left in the financial year including the month in which the asset is acquired.
- An asset is bought in July, assuming a March balance date, depreciation would be calculated for nine months from July to March (inclusive).
Not all fixed assets are able to be depreciated for tax purposes; land for instance. Buildings are not able to be depreciated from the 2012 financial year.
If a fixed asset costs under $500 and is not part of a larger group of assets, then the fixed asset can be claimed 100% for tax purposes at the time of purchase and does not need to be depreciated.
- A chair costs $400, and is bought for use in the office. As the cost is under $500, this chair is able to be claimed for tax purposes immediately on purchase.
- A chair costs $400 and six are bought along with a table which costs $1,000. As the chair is bought as part of an overall fixed asset of the table and chairs, all the items must be depreciated.
On the disposal of a fixed asset, depreciation ceases to be able to be claimed in the financial year (of disposal). An adjustment needs to be calculated of the profit or loss on disposal of the fixed asset, which is either taxable or deductible. Any disposal proceeds in excess of the cost of the fixed asset will generally be tax free.
- A fixed asset which originally cost $1,000 has a written down tax value (value after deducting depreciation claimed to date) of $500 is sold for $400. A loss on disposal of $100 has occurred which is tax deductible.
- A fixed asset which originally cost $2,000 but has a written down value of $750 is taken to the tip and dumped. A loss on disposal of $750 has occurred which is tax deductible.
- A fixed asset which originally cost $5,000 but has a written down value of $2,000 is sold for $9,000. A profit on disposal of $3,000 has occurred which is taxable, and also a capital gain of $4,000 has been made which is tax free.
Any fixed asset which is used both for business purposes and private purposes by a self employed individual in business in their own name or in partnership with others, or by a trust, may only claim depreciation to the extent of the business use. For fixed assets owned by a company which are not used solely for business purposes, other tax rules apply such as fringe benefit tax.
- A motor vehicle is used by Sam for both business use and private use. His total kilometres travelled are 10,000 kilometres per annum, with 6,000 kilometres for business use (60%). If depreciation based on 100% business use is $2,000, Sam would be allowed a tax deduction of $2,000 x 60% = $1,200.