What does accelerated depreciation mean for my business?

A popular strategy used by government to stimulate spending has been accelerated depreciation of assets. Otherwise know as the instant write-off or small business tax break. Here we explore what it is, and what it means for you

In a simplified sense, what this means is that any small business can bring forward deductions that they wouldn't have otherwise been able to.

In the news you might see it discussed as a benefit to cashflow. But what does this mean for your business? And how much of an impact will it make?

First of all - let's define a Depreciating Asset. A depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. Vehicles, IT hardware, equipment, and office furniture are examples of depreciating assets.

You can claim a deduction on the depreciation of the asset. This claim is generally based on the effective life of the asset (the number of years the asset can be effectively used to produce income) and the depreciation method you choose.

So let's see what this looks like ...

Let's say you own a company and bought a new server for $10,000 to store files and manage the office. This server has an effective life of 4 years, and you are using the prime cost method of depreciation.

Under a traditional system -

		YR1	YR2	YR3	YR4
Asset purchase	<10,000>
Depreciation Expense		2,500	2,500	2,500	2,500
Tax Reduction		750	750	750	750

You buy a new server for $10,000
After YR 1 you claim 25% * $10,000 or $2,500 as depreciation on the asset
You receive a tax reduction of 30% * $2,500 or $750
Over years 2-4 you claim the 25% ($2,500) to receive a tax reduction of $750 each year
Over the 4 years you have a total reduction in your tax of $3,000
The net cash outflow over the 4 years is negative $7,000 ($10,000 spent with $3,000 in tax benefits)

Under accelerated depreciation (and to keep it simple we'll apply a 30% tax rate) -

		YR1
Asset purchase	<10,000>
Depreciation Expense		10,000
Tax Reduction		3,000

You buy a new server for $10,000
You immediately claim 100% * $10,000 as depreciation on the asset
You receive a tax reduction of 30% * $10,000 or $3,000
The total effect on your net cashflow is negative $7,000

The point here is that the net result is the same - you invest $10,000 and you reduce your tax by $3,000. The difference is that you can bring forward the depreciation to increase your available cash sooner. It's also important to highlight here that a tax deduction ($10,000) doesn't equal a tax reduction ($3,000). The benefit you receive from the instant write-off won't ever equal the initial investment.

So if you aren't making a profit or expecting to pay much tax - does the small business tax break really help you? Well no. If your business is expected to make a profit in the future, you may be better off waiting to claim the deduction in future years.

The hidden danger of measures like this is that they encourage businesses to spend money - but unless you already had plans to purchase an asset, or have a real business need to update equipment then it may not be the best decision for your business.

Have a chat with your accountant or bookkeeper before making the decision, and discuss how the instant tax writeoff could affect your cashflow.