Assets and depreciation

Effective life

Effective life is the period an asset can be expected to be useful for earning income, and it is used to work out how quickly its cost is deducted as depreciation.

Effective life is the number of years a depreciating asset can reasonably be expected to be used for a taxable purpose, such as producing income, when maintained and used in the normal way. It sets the speed at which you deduct the asset's cost. A longer effective life means smaller deductions each year, while a shorter life means larger deductions over a shorter period.

You have two main choices for working out an asset's effective life. You can use the figure published by the ATO for that type of asset, which saves time and gives certainty, or you can make your own estimate based on your circumstances, such as heavy use or unusual conditions. If you self-assess, you should keep records explaining how you arrived at the figure, because the ATO may ask.

The published effective lives are reviewed from time to time and the lists are updated, so the right figure for an asset depends on when you start to use it. For this reason the ATO website is the place to check the current life for your asset type, rather than relying on an old table or a rule of thumb.

Once you have the effective life, you plug it into either the prime cost method or the diminishing value method. In the prime cost method the cost is spread evenly across the life. In the diminishing value method the deduction is a percentage of the remaining value, with the percentage based on the effective life, so deductions are larger in early years. Choice of method generally applies to the asset, and once chosen it is not normally changed.

For GST purposes, effective life does not change how credits work. A GST-registered business generally claims the full credit on the purchase in the period of the invoice. However, a long effective life affects the pattern of income tax deductions, which in turn affects the after-tax cost of the asset. It can be useful for cash flow planning to compare how different assets will be deducted.

Mistakes include choosing an unrealistically short life to accelerate deductions, using the same life for different types of asset, and forgetting to reassess when circumstances change materially. If the actual condition or use of an asset changes, you can sometimes recalculate. This is general information only, so confirm your situation with the ATO or a registered tax professional.

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