Should You Use Prime Cost or Diminishing Value as your Tax Depreciation Method?

by Steve Wynn, Managing Director

To understand which tax depreciation method is best suited to your situation, you first need to understand the difference between the two methods - Prime Cost and Diminishing Value.

Prime Cost (or Straight Line depreciation) is simply equal amounts of depreciation of an asset over a set number of years.

For example, if an asset costs $1000.00 and has an effective life of 10 years then the equal yearly instalments of depreciation over 10 years would be $100.00 p.a.

Diminishing Value allows you to accelerate depreciation which means you can claim more now but less in the future. As the name implies, it diminishes over time.

Now when you ask these two important questions, you can choose the method best suited to you.

  • Is the Prime Cost method of Depreciation relevant anymore?

  • Do circumstances still exist that that you would choose the Prime Cost method of Depreciation over Diminishing Value?

Here in the table below, are examples of both the Prime Cost and the Diminishing Value methods and the total depreciation cost each year up to a 10 year period.

As you can see, Diminishing Value method allows you to claim $200.00 in the first year whereas Prime Cost method only allows the set amount of $100.00. With time, the Prime Cost method still delivers a claim of $100.00 per annum where Diminishing Value starts to drop off.

So why would you (or anyone for that matter), choose the Diminishing Value method over the Prime Cost method?

From my 20 odd years working here at Write It Off, here are some of the main reasons I have come across that may help you to further decide which is the best method for you:

  • You may plan to hold the property for many years so you will get your full claim in the end anyway. But this is not always the case and circumstances change. If for unforeseen reasons you have to sell the property, you have missed out on some of the claim amount you thought you were going to see.

  • Having more money today allows you to invest more now for the future. If you wait until tomorrow (or next year) to invest then you have missed out on potential capital gains. Remember the saying "time is more important than timing" This means that for a start it is very hard to pick the best time to invest in the market and historical evidence shows those who leave their funds in the market the longest do better than those who try and pick the best time to put their hard earned money into the market.

  • But the most important reason is "the time value of money". Today $1.00 is worth more than $1.00 tomorrow. The reason for this is inflation. We all know that everything goes up in price which means the purchasing power of our dollar goes down. So having extra money today is better than waiting until next year or the year after to make the bigger depreciation claim. This is a good reason as to why you should take advantage of legitimate tax deductions as soon as they become available.

So is the Diminishing Value method always going to be better then?

Lets say you own a property for a few years and during this time you lived in it. Then you decide to rent it out, earn some income and claim the expenses - including depreciation.

The important thing to note here is the assets or the plant and equipment. For example; an oven costing $1000.00 starts to depreciate in the eyes of the Australian Tax Office as soon as it is installed.

So if you lived in the property for 4 years then your oven has already lost 4 years worth of value and depreciation. When you get your depreciation schedule prepared for tax purposes, you get to choose which method of depreciation to adopt - but remember, what ever method you choose, from this point you must continue with for all assets in the property, you cannot change methods half way through.

Looking at the table above, if you start to make a depreciation claim using the Diminishing Value method from year 5 onwards, then you can claim $81.92 in this year and it goes down in amounts from there.

If you choose the Prime Cost method, you get to claim $100.00 in year 5 and continue to claim $100.00 for the remaining life of the asset. Therefore, in this case, Prime Cost is the better choice.

Remember this is general advice only and you need to discuss your personal situation with your trusted tax agent.