Tax Tip 133: Choice of Depreciation Method and Debt Recycling

Choice of Depreciation Method and Debt Recycling

Should you use Prime Cost Method or Diminishing Value Method when claiming depreciation?


This topic is discussed here:
Depreciation: Prime Cost Method vs. Diminishing Value Method


There is a potential advantage for claiming the method that gives you the greatest return early on. Claiming higher depreciation will result in great tax deductions with the money saved being able to be used to debt recycle – pay down the non-deductible debt and reborrow to invest. You will be converting non-deductible debt into deductible as well as increase the asset base quicker for maximising compounding.


Where you renting out the property immediately this may be the Diminishing Value Method. Where renting the property out later it may be the prime cost method. Seek the advice of your tax advisor to work this out.


The savings may initially be relatively minor, but with the effects of compounding the impact of the savings will grow.

 

The depreciation method cannot be changed once commenced so choose carefully. Although I did see a recent tax case where a taxpayer sought special leave of the Commissioner to extend the period of amendment so that a unforseen issue which affected the taxpayer choice of method was allowed. The Commissioner adopted the view that once this issue was evident that the taxpayer had to appeal quickly (30 days) for extra time to amend and yes the Commissioner allowed them to change method.

Yes a property that is initially a PPOR and later an IP you may choose the PC mtd if your QS report. One of the benefits of a good QS is they will actually indicate the two options and the benefit will be quite apparent on the summary / comparison page/s.

Also Div43 capital allowances are always prime cost. Therefore, the variance between the two methods is rather minor once the Div 43 is extracted.

 

I've debated this with each of my properties. When purchased purely for rental with no PPOR period, Diminishing Value clearly givens bigger benefits in the early years.
You can start to think "but my salary is increasing so I should claim the smaller (prime cost) amount now and save more deductions for later" but ultimately, we can't predict what will happen in future - marginal tax rate changes, negative gearing changes, maternity leave periods etc.
And of course the golden rule - time value of money. $1 now is worth more than $1 next year.

Even though I know my employment income is likely to rise in the next few years, so probably a higher marginal rate, I feel much more comfortable taking the larger (diminishing value) deduction now while it is certain.
If I were planning to take maternity leave in 6 months though, it would make me think much much harder. All comes down to your circumstances.

 

I think you are right.

but there are some other situations where the PM method may be better - such as where the property was lived in in the early years

 

Do people tend to get depreciation reports done for properties they buy to move into? What if the depreciation report wasn't done until a PPOR was being turned into an IP?

 

I think it would be uncommon, unless it was going to be rented out first.

If a PPOR is being turned into an IP you can get a depreciation report when this happens.

 

Ok so given that depreciation reports are typically done around the point of turning a property into an IP (whether you've just bought it, or have lived in it for a while), I don't quite understand where comments like

fit in the picture. ie in the first quote, why would you have a depreciation report done if you're not renting it out until later, and in the second quote, you wouldn't have a depreciation report until you've finished living in the property...? Sorry if I'm missing something obvious.

 

Because assets depreciation over their life spans. Close to the time the asset was acquired there would be higher amounts to claim if diminishing value. There comes a point when the prime cost method will give you more to claim and this will vary from item to item and depend on when the property is first rented out.

 

Righto thanks for clarifying