The ABCs of Depreciation

There’s been a bit of talk recently about depreciation on commercial buildings.

This is because two of the major political parties will remove this as a tax-deductible expense after the election. When you own a commercial building and lease it out, it's a form of business activity. Therefore, you must declare the income (rent/lease) and you can claim the expenses incurred in operating the premises - like interest expenses, repairs, administration etc.

Less expenses to claim mean higher profits and therefore higher taxes for commercial landlords.

So what exactly is depreciation and how does it work?

Let’s get some?accounting 101?going.

Depreciation refers to the decrease in the value or worth of an asset over time due to the likes of wear & tear, obsolescence, or changes in market conditions.

Depreciation allows for the cost of the asset to be written off over it’s useful life.

Put simply; depreciation reflects the decrease in value of an asset over time.

Each asset depreciates at a different rate/percentage.

Some people think that the purchase price of an asset is tax deductible but this is not the case, the depreciation expense is.?

I.e. clients will often say ‘I bought this asset (usually a car) before the end of the financial year because that brings my tax bill down’. Not quite!

The depreciation (if allowed) on that asset is the expense that brings the profit down and saves some tax. Now for some?accounting and tax 201...

In New Zealand, at the moment for tax purposes (in business), people look at an asset as something that costs over $1,000 because we have what is called a low value asset threshold.

This low value asset threshold ($1,000) means that if a business buys an asset that is under this, it can claim it as a 100% tax-deductible expense.

This increases expenses, and decreases profit, leading to lower taxable profits.

Admittedly, businesses can’t buy too many assets under $1,000 these days, but you might buy an office speaker, office TV, couch, screen, phone etc.

But as soon as that asset (i.e. an iPad, computer, iPhone etc) is over $1,000, it won’t qualify for the low value asset threshold and will need to be depreciated.

As you now know from above, each asset depreciates at a different rate/percentage. During the financial year, this depreciation amount?is the expense to the business, NOT the cost of the iPad, computer, iPhone etc. Now, back to the landlords.

For the last couple of years, commercial landlords have been able to claim depreciation on their buildings. But there is a proposal to remove this. I can hear some of you saying; 'what about private buildings like rental properties?'.

There is no available claim on residential buildings for private landlords anymore. There once was though. From 1st April 2011, the rules do not allow for a claim of depreciation on buildings with an estimated life of 50 years or more. I.e. most standard rental properties.

However, some landlords will value their chattels and depreciate them as stand-alone assets. I.e. air conditioning units, new carpets, dishwashers, lawnmowers, blinds, you get the drift.

The depreciation on these chattels creates an on paper expense which decreases the profits from rental income and therefore tax to pay.

Remember: income less expenses = profit. Profit is what you pay tax on. Now for a quick bit of?accounting?301, understand this... When you claim depreciation as an expense in a financial period you reflect the value of the asset decreasing. The asset then has a carrying 'book value' (purchase price less total depreciation). BUT if you eventually sell that asset for more than the assets 'book value' you will have what is called 'depreciation recovered'.

Depreciation recovered is a form of income and reflects the fact that you claimed too much depreciation.?This will be the sale price less the book value. Righto, you should know enough to take a uni lecture next week now.?

In all seriousness, you may not feel like depreciation is applicable to you right now, but it’s good to have a grasp of what it is and how it works.

?Hopefully, that helped do exactly that for you.

Have a great weekend,

Luke

P.s. You are one of?8,350+?recipients. Know?someone you could share this with? The KTC podcast had over?65,000?downloads in August. _____________________________________________________________________ Did you know: a commercial building depreciates at 1.5 % to 2% per annum. I.e. a $1,000,000 building may have a $20,000 depreciation expense for a full 12-month financial year.

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