Depreciation is indeed a method of allocating the cost of a depreciating asset over its effective life, reflecting its usage, wear and tear, or obsolescence.
This helps businesses more accurately match expenses with the income generated by those assets, which is key for financial reporting and tax purposes.
The Australian Taxation Office (ATO) provides guidance on how to determine the effective life of assets through Taxation Ruling TR 2022/1, which took effect from 1 July 2022. This ruling outlines how the Commissioner estimates the effective life of various depreciating assets under section 40-100 of the Income Tax Assessment Act 1997.
It includes detailed tables (Tables A and B) listing effective lives for assets across different industries and general categories.
As their adviser, you can assist clients by either:
Property remains a popular asset class within SMSFs, offering trustees long-term growth potential and control. Key benefits your clients may gain include:
When advising clients on SMSF property strategies, ensure the following are addressed:
Scenario: A couple, both individual trustees of their SMSF, plan to purchase a $700,000 residential investment property in Sydney to generate rental income and long-term capital growth.
1. Review the Investment Strategy
Ensure the SMSF’s investment strategy explicitly allows for direct property investment. It should adequately address risk, liquidity, diversification, and retirement objectives. Assist your clients in updating the strategy if necessary.
2. Confirm Sole Purpose Compliance
Advise your clients that the investment must strictly satisfy the sole purpose test. It must provide retirement benefits only. Make clear that personal use is prohibited, including by themselves or related parties.
3. Guide Proper Structuring
If the purchase involves borrowing, help set up a compliant Limited Recourse Borrowing Arrangement (LRBA). A bare trust will need to be established to hold the legal title of the property until the loan is repaid. Ensure all structuring meets SIS Act requirements.
4. Coordinate Financing
Assist the SMSF in securing appropriate funding. In this example, the fund borrows $500,000 and uses $200,000 from its own reserves. Ensure the loan terms meet limited recourse rules. Only the property should be at risk in the event of default.
5. Maintain Arm’s Length Standards
Ensure all transactions are conducted on commercial terms. This includes purchasing the property at market value and leasing it to unrelated tenants at a fair market rate.
6. Oversee Ongoing Compliance
Remind trustees of the importance of:
7. Plan for Exit
Work with your clients on an appropriate exit strategy. Upon retirement, the property may be sold (with capital gains potentially tax-free in the pension phase), or retained as a source of income.
When advising SMSF clients on newly acquired residential property, it’s important to consider both capital works deductions under Division 43 and depreciating asset deductions under Division 40 of the Income Tax Assessment Act 1997.
Division 43 – Capital Works Deductions
Capital works deductions apply to structural elements of the property and eligible fixed assets.
In practice, these deductions can significantly reduce the fund’s taxable income over time. Ensure that the property is income-producing and that a qualified quantity surveyor is engaged to accurately allocate costs between land, structural elements, and plant and equipment.
In this scenario, your SMSF client acquires a brand-new residential property for $700,000 on 1 August 2024.
Assumptions:
Step 1: Determine the Deductible Amount
Assuming the building portion is $500,000, the SMSF may claim capital works deductions as follows:
$500,000 × 2.5% = $12,500 per annum
Step 2: Apply First-Year Pro-Rata (2024–25)
Given the property is held for 11 months in the 2024–25 financial year:
$12,500 × (11 ÷ 12) = $11,458
Your client’s SMSF can therefore claim $11,458 in deductions for 2024–25, and $12,500 annually thereafter, for up to 40 years, provided the asset remains eligible.
Depreciating assets in rental properties – Division 40
In the context of Australian rental properties, depreciating assets are items within the property that decline in value over time due to wear and tear and they can be a goldmine for tax deductions if used wisely.
Depreciating Assets in SMSF Rental Properties – Division 40
Under Division 40 of the Income Tax Assessment Act 1997, depreciating assets in residential rental properties represent a valuable opportunity to maximise deductions for your SMSF clients.
These assets are distinct from the building’s structure and typically have a shorter effective life due to wear and tear.
Depreciating assets are generally removable, mechanical, or non-structural items installed in the property. Common examples relevant to SMSF-owned rental properties include:
For new properties, both Division 40 and Division 43 deductions can apply.
However, advisers should note that second-hand plant and equipment assets acquired after 9 May 2017 generally do not qualify for Division 40 deductions unless they are brand-new and installed in an income-producing context.
When structuring SMSF property investments, identifying and correctly classifying these assets early, with support from a qualified quantity surveyor, can unlock substantial tax benefits and ensure ongoing compliance.
These assets are claimed under Division 40 of the Income Tax Assessment Act 1997.
There are two primary methods for claiming depreciation on depreciating assets within SMSF-owned rental properties:
The effective life of each asset can either be:
Assets costing $300 or less may qualify for immediate deduction, provided they are:
Proper structuring and documentation of depreciation strategies can significantly improve after-tax returns and support SMSF compliance.
Depreciation Example: Air Conditioner in a Residential SMSF Property
This example demonstrates how to calculate depreciation using the diminishing value method for an SMSF-owned rental property.
Scenario:
Your SMSF client purchases a brand-new split-system air conditioner for $2,400, installed on 1 August 2024 in an income-producing residential property.
Under TR 2022/1, the effective life of a split-system air conditioner is 10 years.
Step 1: Depreciation Rate Calculation
Using the diminishing value formula:
Depreciation rate = 200% ÷ Effective life
= 200% ÷ 10
= 20%
Step 2: First-Year Deduction (Pro-Rata)
Since the asset was installed on 1 August 2024, depreciation applies for 11 months of the 2024–25 financial year.
Deduction = Base value × Depreciation rate × (11 ÷ 12)
= $2,400 × 20% × (11 ÷ 12)
= $440
Step 3: Depreciation in Subsequent Years
For each year after installation, the SMSF should apply 20% to the opening adjustable value of the asset to calculate depreciation under the diminishing value method.
The complete depreciation schedule for the asset’s effective life is outlined in the table below. This provides a clear view of how the asset’s value reduces over time and helps in planning future deductions accurately.
| Year | Opening Value | Deduction | Closing Value |
|---|---|---|---|
| 2024–25 | $2,400.00 | $2,400 × 20% × 11/12 = $440.00 | $1,960.00 |
| 2025–26 | $1,960.00 | $1,960 × 20% = $392.00 | $1,568.00 |
| 2026–27 | $1,568.00 | $1,568 × 20% = $313.60 | $1,254.40 |
| 2027–28 | $1,254.40 | $1,254.40 × 20% = $250.88 | $1,003.52 |
| 2028–29 | $1,003.52 | $1,003.52 × 20% = $200.70 | $802.82 |
| 2029–30 | $802.82 | $802.82 × 20% = $160.56 | $642.26 |
| 2030–31 | $642.26 | $642.26 × 20% = $128.45 | $513.81 |
| 2031–32 | $513.81 | $513.81 × 20% = $102.76 | $411.05 |
| 2032–33 | $411.05 | $411.05 × 20% = $82.21 | $328.84 |
| 2033–34 | $328.84 | $328.84 × 20% = $65.77 | $263.07 |
The SMSF can continue to claim 20% annually on the declining balance until the asset is fully depreciated, with the remaining residual value written off when it becomes negligible.
Prime Cost Method Example (same asset, different approach)
Using the same scenario, an SMSF installs a brand-new split-system air conditioner valued at $2,400 on
1 August 2024, but applying the prime cost method instead:
Step 1: Determine the Depreciation Rate
Under the prime cost method, depreciation is calculated at a consistent annual rate over the asset’s effective life:
Depreciation rate = 100% ÷ Effective life
= 100% ÷ 10 = 10%
Step 2: First-Year Deduction (2024–25)
Since the asset was installed on 1 August 2024, the SMSF can claim depreciation for 11 months in the 2024–25 financial year:
First-year deduction = $2,400 × 10% × (11 ÷ 12) = $220
Step 3: Full-Year Deduction from 2025–26 Onward
For the remaining 9 years, the fund can claim an annual deduction of $240, calculated as:
$2,400 × 10% = $240
This method provides stable, predictable deductions year-on-year, ideal for long-term tax planning within the SMSF.
Full Depreciation Schedule (Prime Cost Method)
The table below outlines the full 10-year depreciation schedule for a $2,400 split-system air conditioner, using the prime cost method. This method applies a fixed rate of 10% annually over the asset’s effective life.
The first year reflects a pro-rata deduction for 11 months, given the asset was installed on 1 August 2024. Each subsequent year shows the fixed annual deduction and the asset’s declining closing value.
This structured view allows advisers to quickly reference annual depreciation values, support client recordkeeping, and plan SMSF cash flow obligations accurately.
| Year | Depreciation Formula | Deduction | Closing Value |
|---|---|---|---|
| 2024–25 | $2,400 × 10% × (11 ÷ 12) | $220.00 | $2,180.00 |
| 2025–26 | $2,400 × 10% | $240.00 | $1,940.00 |
| 2026–27 | $2,400 × 10% | $240.00 | $1,700.00 |
| 2027–28 | $2,400 × 10% | $240.00 | $1,460.00 |
| 2028–29 | $2,400 × 10% | $240.00 | $1,220.00 |
| 2029–30 | $2,400 × 10% | $240.00 | $980.00 |
| 2030–31 | $2,400 × 10% | $240.00 | $740.00 |
| 2031–32 | $2,400 × 10% | $240.00 | $500.00 |
| 2032–33 | $2,400 × 10% | $240.00 | $260.00 |
| 2033–34 | $2,400 × 10% | $240.00 | $20.00 |
| 2034–35 | Remaining value | $20.00 | $0.00 |
Depreciation Comparison Table Diminishing value method versus Prime cost method
The table below compares the Diminishing Value and Prime Cost depreciation methods over a 10-year period for a $2,400 split-system air conditioner. It highlights the deduction available each year under both approaches, along with the annual difference.
This side-by-side view allows advisers to:
As shown, the Diminishing Value method delivers higher deductions in the earlier years, while the Prime Cost method spreads deductions evenly across the asset’s effective life.
| Year | Diminishing Value Deduction | Prime Cost Deduction | Difference |
|---|---|---|---|
| 2024–25 | $440.00 | $220.00 | +$220.00 |
| 2025–26 | $392.00 | $240.00 | +$152.00 |
| 2026–27 | $313.60 | $240.00 | +$73.60 |
| 2027–28 | $250.88 | $240.00 | +$10.88 |
| 2028–29 | $200.70 | $240.00 | –$39.30 |
| 2029–30 | $160.56 | $240.00 | –$79.44 |
| 2030–31 | $128.45 | $240.00 | –$111.55 |
| 2031–32 | $102.76 | $240.00 | –$137.24 |
| 2032–33 | $82.21 | $240.00 | –$157.79 |
| 2033–34 | $65.77 | $240.00 | –$174.23 |
The Diminishing Value method can significantly boost deductions in the initial years.
Particularly beneficial for SMSFs seeking early-stage tax offsets.
However, the Prime Cost method offers greater consistency, making it easier to forecast long-term deductions. Advisers should consider the client’s investment horizon, cash flow needs, and long-term tax position when recommending a method.
When it comes to depreciation strategies for SMSFs, the best tax advice is all about maximising deductions while staying compliant with superannuation and tax laws.
For Division 40 assets:
The optimal method will depend on their cash flow preferences and long-term strategy.
Note: SMSFs cannot claim Division 40 deductions on second-hand assets in residential properties acquired after 9 May 2017.
2. Recommend a Tax Depreciation Schedule
Encourage clients to engage a qualified quantity surveyor to prepare a comprehensive depreciation schedule. This helps ensure:
This is particularly important for newly constructed properties or those with significant renovations, where the potential for maximising deductions is highest.
3. Identify Immediate Deduction Opportunities
For eligible rental properties held within an SMSF, remind clients that certain low-cost assets may qualify for immediate deductions:
These strategies can improve short-term cash flow and optimise the fund’s overall tax position. Ensure clients are aware of ATO criteria and reporting obligations.
4. Align Depreciation Strategy with SMSF Phase
Advise clients to consider how depreciation impacts the fund’s tax position depending on its current phase:
Strategic timing of asset purchases, disposals, and major claims can significantly influence after-tax outcomes.
Encourage forward planning to align depreciation strategy with the client’s retirement timeline.
5. Maintain SMSF Compliance with Depreciation Claims
Advisers should guide clients to stay compliant when claiming depreciation within an SMSF:
This approach supports accurate reporting and reduces audit risk.
Understanding how to leverage depreciation under Division 40 and Division 43 can significantly improve after-tax returns for your SMSF clients. By selecting the right methods, maintaining compliant documentation, and aligning depreciation strategies with your clients’ retirement goals, advisers can deliver meaningful financial outcomes. Whether it’s a brand-new build or a long-term investment, depreciation planning remains a powerful tool within your advisory toolkit.
Contact our SMSF specialists to discuss your clients’ circumstances or access our full range of SMSF administration and support services.
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