Should you use Prime Cost or Diminishing Value

Should you use Prime Cost or Diminishing Value

The question needs to asked 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? To answer these questions we first need to briefly explain the difference between the two methods.

Prime Cost or Straight Line depreciation is the simply equal amounts of depreciation of an asset over a set number of years. So 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. However Diminishing Value allows you to accelerate depreciation which allows you to claim more now but less in the future. The table below represents the two methods

Purchase price of asset$1,000.00
Effective life of asset10
YearsPrime CostDiminishing Value
Total Depreciation$1000.00$892.63

As you can see, Diminishing Value allows you to claim $200.00 in the first year whereas Prime Cost only allows $100.00. However as time goes on Prime Cost still delivers a claim of $100.00 p.a where Dimishing Value starts to drop off. Generally, the saying "a dollar today is better than a dollar tomorrow" is true. If you can take the bigger claim now then you should do it for many reasons. Among them are:

  • You may plan to hold the property for many years so you will get your full claim in end anyway. But this is not always the case and circimstances change. If for unforseen reasons you had to sell the property you have missed out on some of the claim the thought you were going to get.
  • 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 you try and pick the best time to put their money into the market.
  • But the most important reason is "the time value of money". $1.00 today 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 why you should always take advantage of legitimate tax deductions as soon as they become available.

So this must mean that Diminishing Value is always better? 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 rent and claim the expenses, including depreciation. The important thing to note here is assets, say a $1000.00 oven start to depreciate in the eyes of the Tax Commissioner as soon as they are installed and ready for use. So if you lived in the property for say 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 you adobt. 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. So if you look 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 gets worse from there. However 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 a trusted tax agent.