Diminishing Value Depreciation

Diminishing value depreciation is one of two methods to calculate the depreciation of an asset. With this method, you’ll front load your tax deductions by leveraging from the larger loss of an asset’s value in its earlier years of use.

For property investors, using diminishing value to calculate their deductible depreciation can help with the headache of large tax bills, especially in the initial years of owning an investment property.

What is Diminishing Value Depreciation?

Better known as the diminishing value method, it’s used to calculate an asset’s remaining value at the beginning of each year, recording higher depreciation expenses in the early years of an asset’s life and lower expenses in later years. This is a very different method to the prime cost method, which calculates depreciation based on its original cost (and uses the same amount each year). More on the differences later.

If you’re recording significant income in the earlier years of your property’s ownership—or perhaps if you’ve additional deductions to claim later in its life—this method could be relevant to you.

How diminishing value relates to property depreciation

This method allows property investors to claim larger tax deductions on the wear and tear of real estate and its fixtures in the early years after buying or building. It can significantly boost cash flow during this period as a result.

Property investors can use the diminishing value method to claim more significant depreciation deductions from items like fittings (and of course the building itself) upfront. This could drastically reduce your tax burden at your property’s first tax assessment; a welcomed relief after spending a tonne of capital on such a significant purchase.

How is diminishing value depreciation calculated?

To calculate diminishing value depreciation, you need to know the asset’s base value, the asset’s effective life and ATO’s current diminishing value rate (currently 200 per cent). Find out more about the ATO’s two alternative methods on their website.

The formula for diminishing value depreciation is:

Depreciation Expense = Base Value × (Days Held ÷ 365) × (200% ÷ Asset’s Effective Life)

• Base value: The opening value of the asset (cost or written down value).
• Days held: The number of days the asset was held during the financial year.
• 200%: This is a fixed percentage set by tax authorities to apply the diminishing value method.
• Asset’s effective life: The expected usable life of the asset, provided by the ATO.

Diminishing Value vs. Prime Cost Method

Both diminishing value method and the prime cost method will impact your tax deductions and long-term investment strategy differently.

• Diminishing value method: You’ll front load your depreciation expenses with the DV method, letting you claim bigger deductions earlier in the asset’s life. Want to maximise your cash flow in the early years of the investment (without the tax burden)? This might be a wise route.
• Prime cost method: The prime cost method spreads depreciation amounts evenly across the asset’s effective life, similar to loan amortisation. Each year, you’ll claim the same amount of depreciation, meaning consistent deductions every year (until you can’t claim anymore).

We’ve used the diminishing value method more often during our time as property investors, but this by no means guarantees it’s the right method for you and your investment. Consult your accountant or financial planner for the answer to that question.

The case for diminishing value

By front loading your depreciation deductions, you can improve your cash flow, which could be reinvested into improving the premises or placed into other investments.

But the best method for you will depend on your specific investment strategy, your financial situation and the nature of the assets you’re depreciating. Your financial planner or accountant will be the go to resource in ensuring you choose the best route.

Smart investing means tax-effective investing. Always consider the tax implications of every investment and empower yourself with as much tax knowledge as possible before you invest. And, once again, consult with your tax professional for the most up to date information on Australia’s tax laws.