Diminishing value vs prime cost methods for claiming depreciation

As a property investor claiming tax depreciation, you have the option to choose between using the Prime Cost (straight line) method and the Diminishing Value method of depreciation. Understanding the differences between these methods and their benefits can help you make an informed decision that best suits your investment strategy. 

Diminishing Value Method

The Diminishing Value method of depreciation applies the nominated depreciation rate to the written-down value of the asset each year. This means higher depreciation values are claimed earlier in the life of the asset, with deductions diminishing over time. This method provides a greater tax deduction and return to the investor up front, with deductions decreasing as the asset ages. 

Prime Cost Method

The Prime Cost method of depreciation applies a consistent rate of tax depreciation to the starting value of the asset, so that it depreciates at the same value every year for the life of the asset. This strategy means a more consistent value of deductions and returns are achieved for the investor over the life of the property. 

Table Illustrating Diminishing Value and Prime Cost Methods

Let’s consider a standard Division 40 asset: a security system costing $2,500, with an effective life of 5 years as prescribed by the ATO. 

* Table and graph showing the comparison of tax depreciation deductions over time using both Prime Cost and Diminishing Value methods.

Diminishing Value Method 

Using the Diminishing Value method, the depreciation rate is applied to the written-down value of the asset each year. Assuming a depreciation rate of 40%, the calculations would be as follows: 

• Year 1: $2,500 * 40% = $1,000 
• Year 2: ($2,500 – $1,000) * 40% = $600 
• Year 3: ($2,500 – $1,600) * 40% = $360 
• Year 4: ($2,500 – $1,960) * 40% = $216 
• Year 5: ($2,500 – $2,176) * 40% = $130 

Total depreciation over 5 years: $1,000 + $600 + $360 + $216 + $130 = $2,306 

Prime Cost Method 

Using the Prime Cost method, the depreciation rate is applied to the initial cost of the asset each year. Assuming a depreciation rate of 20%, the calculations would be as follows: 

• Year 1: $2,500 * 20% = $500 
• Year 2: $2,500 * 20% = $500 
• Year 3: $2,500 * 20% = $500 
• Year 4: $2,500 * 20% = $500 
• Year 5: $2,500 * 20% = $500 

Total depreciation over 5 years: $500 * 5 = $2,500 

Benefits of Each Method 

Diminishing Value Method 

• Higher Initial Deductions: Provides larger deductions in the earlier years, which can be beneficial for investors looking to maximise their tax deductions upfront. 
• Accelerated Depreciation: Useful for assets that lose value quickly or become obsolete faster. 

Prime Cost Method 

• Consistent Deductions: Offers a steady and predictable amount of depreciation each year, which can simplify financial planning and forecasting. 
• Long-Term Stability: Ideal for investors who prefer a consistent return over the life of the asset. 

Choosing between the Diminishing Value and Prime Cost methods depends on your investment strategy and financial goals. A quality depreciation schedule prepared by a qualified quantity surveyor will report both methods, allowing you to select the one that best suits your circumstances. Consulting with your accountant can also help you determine the most advantageous method for your specific situation. 

For more detailed advice and to maximise your deductions, consider using a qualified quantity surveyor to prepare your tax depreciation schedule. 

Selecting a Quantity Surveyor

In order to maximise your deductions and minimise your risk, we recommend using a qualified quantity surveyor to undertake the process of inspecting (when required), researching and preparing your capital allowance and tax depreciation schedule.

Are all quantity surveyors and tax depreciation service providers equal?

Absolutely not. But the range in pricing of tax depreciation schedules, compared to the dollars that can be saved over the years, is small. When selecting a quantity surveyor to produce your tax depreciation schedule, you can use the following checklist.

Your quantity surveyor should be:

• Appropriately qualified with a Bachelor of Construction Management or similar;
• A member of a recognised association or body, such as the Australian Institute of Quantity Surveyors;
• A Registered Tax Agent (this is a requirement of the Tax Practitioners Board for all quantity surveyors producing tax depreciation schedules to be relied upon for tax purposes).

In order to report the most accurate and maximum deductions, your quantity surveyor’s report should include:

• A schedule of Division 40 assets and the deductions claimable;
• A schedule of Division 43 costings and capital allowances claimable;
• Reporting of deductions using the Diminishing Value method;
• Reporting of deductions using the Prime Cost method;
• Dates and costings of additions and improvements made to the property by previous owners;
• Dates and costings of additions and improvements you have made to the property;
• Scrapping of any assets removed from the property for replacement during renovations (where applicable);
• Grouping and reporting of low-cost pooling;
• Grouping and reporting of low-value pooling;
• Reporting of assets eligible for immediate write-off;
• Pro-rata reporting for the first year of ownership.

Here at Capital Claims Tax Depreciation, we offer Australia-wide services to help with all your depreciation needs. Call us on 1300 922 220 or get a quote today. We provide depreciation services for both commercial and residential properties. 

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