Depreciation is allowed as a deductible expense for tax because assets decline in value and wear out as they are used.
The depreciation regime creates a statutory right for a taxpayer to claim depreciation. Inland Revenue sets the depreciation rates and, in some circumstances, a taxpayer can apply to Inland Revenue for a special rate.
- Some assets cannot be depreciated for tax purposes, including:
- Trading stock;
- Land;
- Financial arrangements under the accrual rules;
- Goodwill;
- Some types of intangible assets; and
- Low-value assets costing less than $500 which are fully written off at acquisition.
Goods and services tax (GST)
If the taxpayer is not registered for GST, they base their depreciation on the actual price they pay for an asset, including the GST component.
If the taxpayer is registered for GST, they can claim the GST component of an asset’s cost price as an input tax deduction. In this case, they claim depreciation on the GST exclusive price of the asset.
Depreciation methods
There are two ways that a taxpayer can account for depreciation on their assets – either as an individual asset or as part of a group of assets (a “pool”).
If a taxpayer wishes to calculate depreciation on individual assets they can use either of the following methods of depreciation:
- Diminishing value (DV); or
- Straight line (SL).
Alternatively, if the taxpayer wishes to depreciate a group of assets as a pool, then the diminishing value method must be used.
Diminishing value method (DV)
Depreciation is calculated each year by using a constant percentage of the property’s adjusted tax value. The depreciation deduction progressively reduces each year.
Straight-line method (SL)
Depreciation is calculated each year at a constant percentage of the cost of the asset. This method is sometimes referred to as the cost price basis. The amount of depreciation claimed is the same each year.
Pool depreciation method
Taxpayers can depreciate collectively, rather than individually, assets that cost or have an adjusted tax value of $2,000 or less.
When a property is pooled it must be depreciated using the diminishing value method on the average value of the pool for the year.
There is no restriction on the number and/or types of pools that a taxpayer may set up. Different pools may be set up for the same types of assets. This may be useful where the assets are used in different locations or different rates apply. Different rates may apply because of different acquisition dates.
Depreciable property
The amount of depreciation that can be deducted depends on whether the property is “depreciable property”, and the date on which the property was acquired.
“Depreciable property” is assets that might reasonably be expected, in normal circumstances, to decline in value while used or available for use in deriving assessable income, or in carrying on a business to derive assessable income.
The depreciable property does not include items such as those listed above, such as land, trading stock, and financial arrangements.
Intangible property is a depreciable property if it falls within the specific schedule of such items (eg a right to use copyright – see below), and is not specifically excluded by the depreciation rules (eg, land, trading stock).
Depreciable intangible property
The following types of assets are depreciable intangible property:
- The right to use copyright;
- The right to use a design or model, plan, secret formula or process, or other like property or right;
- The right to use the land;
- The right to use plant or machinery;
- The copyright in software, the right to use the copyright in software, or the right to use software;
- The right to use a trademark;
- Management rights and license rights created under the Radiocommunications Act 1989;
- Resource Management Act 1991 consents;
- Plant variety rights, or a right to use plant variety rights;
- Copyright in a sound recording.
Subject to some restrictions, these assets may be depreciated over their legal life on a straight-line basis.
Depreciation rates
The depreciation rates to be used for assets vary according to the date on which the asset was acquired. For assets acquired on or after 1 April 2005 and buildings acquired on or after 19 May 2005, taxpayers must use the rates listed in Inland Revenue’s General depreciation rates. For all assets acquired before these dates, taxpayers should refer to Inland Revenue’s Historic depreciation rates.
Taxpayers are entitled to add “loading” to the specified rate for assets acquired before 21 May 2010. However, this loading has now been removed for assets acquired from that date. If the asset was depreciated at a rate with loading before 21 May 2010, it can continue to be depreciated at that rate for that asset’s lifetime.
Buildings
Taxpayers should also note the following:
- If an item of depreciable property is a building:
- A different depreciation rate, or a nil rate (see below), may apply;
- The 20 percent loading that applies to certain depreciation rates does not apply; and
- A deduction for a loss on items no longer used, or a deduction for a loss on disposal, cannot be claimed except in limited circumstances.
- From the 2011–12 income year, depreciation cannot be claimed on buildings with an estimated useful life of 50 years or more (ie the rate is set at nil). This applies to both commercial and residential properties, including leasehold property.
While the depreciation rate for these buildings is zero percent, the depreciation rate for items used in, but not part of, these buildings remain unchanged, and they can continue to be depreciated separately from the building itself.
- “Fit-out” of commercial and industrial buildings is depreciable. A plant attached to a commercial building is generally an item of commercial fit-out and therefore can be depreciated separately from the building.
- The fit-out of residential premises is generally non-depreciable.
- For residential properties, Inland Revenue has issued guidance on how to determine whether an item is part of a building or separately depreciable. The item will be part of the building if it is in some way attached or connected to the building; or integral to the building (ie the rental property is unable to function without it), or built-in or attached or connected to the building (ie part of the “fabric” of the building).
- Inland Revenue has also issued guidance on what is considered to be a building for depreciation. Essentially, a building is a structure that has walls and a roof, is of considerable size, is meant to last a considerable period, and is generally fixed to the land where it stands. For example, a house would be considered a building; but a dam would not (it lacks walls and a roof).
Changing depreciation methods
A taxpayer can choose between the DV method and the SL method of calculating depreciation for any income year (except for fixed-life intangible property, for which only the SL method can be used). The taxpayer can change the method they use to calculate depreciation of the taxpayer’s assets from year to year, except when the asset is included in a pool.
When the taxpayer changes calculation methods, the value on which they calculate depreciation is the current adjusted tax value, not the original cost price of the asset.
New assets
Irrespective of which depreciation method is used, depreciation is claimed for each calendar month or part of a calendar month that the taxpayer has owned the asset in the income year and in which the asset has been available for use to derive assessable income.
Newly acquired assets can also be added to a pool.
Sale of assets
Depreciation may not be claimed in the year of sale of an asset, except for buildings. Depreciation can be claimed based on the number of months that the building is owned in that calendar year.
When an asset that has been depreciated is sold for an amount different from its written down value (adjusted tax value) then a gain or loss on sale must be recognized for tax purposes.
In calculating the gain or loss on sale the costs incurred in selling the asset, such as commission and advertising, can be deducted from the sale price before the gain or loss is determined. Where the asset has been used for both business and non-business purposes, any loss or gain on disposal must be apportioned between business and non-business use.
Ceasing business
When the taxpayer ceases business and the business property is not sold immediately or is kept for private use, the loss or gain must be accounted for using the market value of the asset at the beginning of the next income year. This does not apply to buildings, which must always be depreciated on cost.
The adjustment is made in the income tax return for the year after the business ceased, even where the loss or gain is not realized until a later income year.
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