Understanding Depreciation:

Understanding Depreciation Methods 

There are two primary methods for calculating depreciation:

1. Straight-Line Depreciation
   In this method, depreciation is calculated based on the original cost of the item, with the same amount claimed every year. For example, if you purchase office equipment for $10,000 and the straight-line depreciation rate is 24%, you would depreciate the asset by $2,400 each year. In the first year, the adjusted tax value of the asset would be $10,000, and after applying the 24% depreciation, it would decrease by $2,400, leaving an adjusted tax value of $7,600. This process continues each year, reducing the asset's value by the same $2,400 annually until the asset is fully depreciated.

2. Diminishing Value Depreciation
   Here, you calculate depreciation on the asset’s diminishing value, so the amount claimed decreases over time. For example, if you have office equipment that costs $10,000 and you use a DV depreciation rate of 33%, the depreciation for the first year would be $3,300 (33% of $10,000), leaving an adjusted tax value of $6,700. In the second year, the depreciation would be $2,211 (33% of $6,700), and the adjusted tax value would then be $4,489. This process continues, with the depreciation amount decreasing each year as the adjusted tax value decreases.

While you don’t need to use the same method for all assets, you must apply the chosen method consistently for each asset within the financial year.

Understanding Who Sets Depreciation Rates

In New Zealand, depreciation rates are primarily set by the Commissioner of Inland Revenue. The Commissioner issues depreciation determinations that establish general, provisional, and special rates for various classes of assets. General rates, also known as economic rates, are the most common. These rates are based on typical asset usage within an industry. 

Find depreciation rates published by Inland Revenue here.

Understanding What Assets Qualify for Depreciation?

Only business-use assets valued over $1,000 should be depreciated. Assets under $1,000 can be fully expensed in the year of purchase. Key points include:

• Assets like stock, land, and intangible assets (such as goodwill) cannot be depreciated.
• Low-value assets can be grouped together and depreciated as a pool, although pooled assets cannot be removed once included.

Understanding Depreciation Rules for Buildings

Depreciation rules used to vary for different types of properties. For example:

• In rental properties, building depreciation cannot be claimed. Depreciation on chattels (like heat pumps or carpets) is deductible.
• Depreciation for commercial buildings was reintroduced in 2021 but will be non-depreciable for the 2025 tax year onward.

The Importance of Accurate Record Keeping

Keeping accurate financial records is essential for claiming tax deductions on depreciation. Here’s what your records should show:

• Fixed assets with proof of purchase
• Depreciation claimed on each asset. Business Like as your accountant will do this.
• Adjusted tax value of each asset. Again, as part of maintaining the asset schedule, Business Like will do this. 

Selling or Disposing of an Asset: Tax Implications

There are two main scenarios when disposing of an asset:

1. Selling an Asset
   If you sell an asset, provide details like the sale date and sale price. Importantly, if the asset sells for more than its depreciated value, you’ll need to pay tax on the difference. If it sells for less, you may claim the difference as a loss.

2. Writing Off an Asset
   To write off an asset, it must meet certain conditions, ensuring it no longer holds value for your business:

   • Cessation of Use: The asset is no longer used for business purposes.
   • No Future Use: Neither you nor any associates intend to use the asset in the future.
   • Uneconomic Disposal: The cost to dispose of the asset exceeds its scrap value.

These conditions don’t apply to buildings or pooled assets. If met, you may claim the asset’s adjusted tax value as a deduction, potentially reducing your taxable income for that year.

Additional Depreciation Tips for Small Businesses

Now that you have an understanding of how depreciation works, here are some other tips. 

• Include Depreciation in Costings
  Since assets don’t last forever, incorporate depreciation into the cost of products or services. This helps build profits you can later use to replace assets.

• Depreciate Based on Usage
  You can only claim depreciation for the months an asset was productive. For example, if you purchased an asset three months before your financial year-end, claim depreciation for those three months only.

• Depreciate Only When Productive
  Depreciation starts only when an asset is actively in use. For example, if equipment is purchased but not installed until a few months later, depreciation begins once it’s operational.

Summary

Maximizing tax benefits through depreciation can greatly impact your business’s bottom line. Accounting software like Xero can help understand and streamline depreciation management. If you have questions or need help, Business Like NZ Ltd is here to assist you with depreciation and tax strategy.

If you would like to know more about tax deductible expenses read here: What expenses are tax-deductible in NZ?

About Business Like NZ Ltd - Auckland Chartered Accountants

Business Like NZ has been providing professional yet affordable tax and accounting advice to the Auckland region for years! If you would like to discuss your business with us, please contact us.