Small business guide to depreciation

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Small business guide to depreciation

Depreciation is basically a reduction in the value of an asset over time. What this means for your business is that if you buy a substantial asset like a computer or a car, you can claim a certain amount of the loss of value over time as a business expense.

It’s also a method of spreading the costs of large assets over time.

It’s important that your business claims the maximum tax advantage from depreciation. It’s a bit like claiming expenses, only you’re claiming just the depreciation amount, not the total cost of the asset. But there’s more to depreciation than just a tax claim, and you need to know how to calculate it as well.

Calculating depreciation

There are two main methods:

  1. Straight line depreciation
    This is when you calculate the depreciation of an item based on the original cost price of the item. You claim the same amount each year.
  2. Diminishing value depreciation
    This allows you to calculate the depreciation cost on the diminishing value of the car, so the amount you claim each year will vary as the value item decreases.

You don’t have to use the same method for all your assets, but you must use the same method on an asset throughout the financial year. Check with your accountant to find out the best method for you.

What depreciates and what doesn’t?

You can’t claim tax for depreciation on all of your business assets. Only those that are for business use, valued over $1000, can be depreciated and the value and life expectancy affect whether they qualify and you can’t claim tax for assets like stock, land, and intangible assets like goodwill so check with your accountant.

You can group low value assets (not buildings) together and depreciate as a pool. Once you include assets in a pool, you cannot take them out.

Depreciation on buildings

There are special rules on depreciation related to rental properties. For example, depreciation on chattels like heat pumps, carpets and ovens may be considered tax-deductible expenses; however, depreciation on the building is not.

More about deductible vs non-deductible expenses for residential rental properties

Changes in 2020 reintroduce depreciation deductions for non-residential buildings for the 2021 and subsequent income years.

More about claiming depreciation on buildings (ird.govt.nz)

Record keeping

It’s really important that all your financial records are kept up to date for many reasons, one of them being the ability to claim tax for depreciation. Most businesses leave this to their accountants, but it’s still important to understand what the schedules need to show:

  • Fixed assets, including proof of purchase.
  • The depreciation claimed.
  • The adjusted tax value of each asset.
  • A compliant invoice.

Selling assets

At the same time that you tell your accountant about the assets bought during a financial year, you should also supply a list of assets sold during the year, including the date of sale and the sale price.

If you get more for an asset than its depreciated value, you’ll pay tax on the difference. If you get less, you can claim the difference as a loss. If you get less for the item than its depreciated value, you can claim the difference as a loss and deduct it from your tax bill.

Additional tips

There are some additional factors that can have an impact on a small business, such as:

  • Include depreciation in your costings – assets don’t last forever, and the depreciation is a cost to your business. So build in the depreciation expense into the costings of your products and services.
  • Depreciation is calculated on a monthly basis – you can only claim depreciation on the number of months that the asset was actually productive in your business. So if you purchased your computer three months before the end of your financial year, you can only claim three months depreciation for that financial period, not a full year.
  • You can only claim once the asset becomes productive – let’s say you order a piece of equipment from overseas. It takes three months to arrive, plus another month to be installed and set up. You can’t claim for these four months. Depreciation starts only when the equipment is actually working.

Summary

What you’re looking to do is fully understand how depreciation works, so that you can maximise your tax benefits. Your accountant will take care of this for you, but it’s still important to understand how it works. Comprehensive accounting software will also help you to understand, manage and calculate depreciation on your business’s assets.

Get in contact to find out more.

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