Prime cost vs diminishing value: what’s the difference? Both options are methods of determining tax depreciation value over the effective life of a new purchase.

Simply put, the prime cost depreciation method affords a fixed depreciation rate on the purchase of a brand-new asset. On the other hand, the diminishing value method has a more significant upfront deduction throughout the first four years of the asset’s life.

The two methods have their benefits; but when an investor makes a claim, they can only choose one of the two options. If you’re reading this, then you’re likely looking to learn a little bit more about prime cost and diminishing value methods, and get the most value out of your tax depreciation claim. This guide will walk you through the benefits of each option for your cash flow, how to calculate diminishing value depreciation and the method for prime cost.

effective life of depreciating assets description

Calculating Prime Cost vs Diminishing Value

How to Calculate the Prime Cost Method

The prime cost method calculates decline in the value of an asset over its effective life at a fixed rate each year. It is a straight-line depreciation method. This is the formula for calculating depreciation from the prime cost method:

Asset’s cost x (days held ÷ 365) x (100% ÷ asset’s effective life)

Say you purchased a new car for $50,000 and it has an effective life of a decade; you can claim 10% of its cost across each of the ten years.

$50,000 x (365 ÷ 365) x 10% = $5,000

These deprecation calculations can continue to be made on the asset until the final value of the asset reaches zero.

How to Calculate the Diminishing Value Method

The diminishing value depreciation method allows you to make a higher depreciation deduction in the first few years of ownership. Unlike the prime cost method, the diminishing value method will decrease in value each year until the value of your property reaches zero. Calculate this depreciation method like this:

Base value x (days held ÷ 365) x (200% ÷ asset’s effective life)

Using the same example as before, if you purchased a car for $50,000, and it also had an effective life of 10 years, your first year’s deduction will be worked out as follows:

$50,000 x (365 ÷ 365) x (200% ÷ 10) = $50,000 x 20% = $10,000

For subsequent years, the base value amount will reduce based on the difference between the value of the current year and the remaining value the following year. In this example, the base value for the second year of the asset will be $40,000: that is $50,000, minus the $10000 depreciation from the first year. You can work out the second year’s deduction as follows:

$40,000 x (365 ÷ 365) x (200% ÷ 10) = $40,000 x 20% = $8,000

The base value in the third year will be $32,000, allowing you a $6,400 claim. The fourth-year base value will be $25,600 with a claim of $5,210 and so on until the final value reaches zero.

Prime Cost vs Diminishing Value

As you can see, prime cost vs diminishing value depreciation methods will claim the same total value over forty years. However, each technique uses different rules and tax depreciation schedule strategies to achieve either more significant upfront claims or a more consistent pattern of claim each year of ownership.

prime cost and diminishing returns comparison

The ATO determines the effective life of a great number of assets. As a property investor, if you choose to make your claim using the diminishing value method of tax depreciation claim, then you will be get a more significant proportion of the property’s cost in the first few years of its effective life. As an investor, you will be entitled to substantial deductions only in the earlier years of owning the property.

On the other hand, prime cost depreciation methods yield the investor a consistent way to claim depreciation until the full value of your property is claimed. The greater deductions in prime cost methods come in the asset’s tax depreciation schedule in later years. Investors looking to maximise their claim later in the asset’s life should look to this tax depreciation schedule and method.

Which Method of Depreciation Should I Use?

Determining the better out of diminishing value and prime cost comes down to a few factors that need to be considered by the investor. Whether you want uniform tax depreciation as provided by the prime cost method or to claim more upfront depreciation value in the initial years of your property’s effective life, sacrificing later value, there are some of the fundamental considerations when choosing between prime cost vs diminishing value:

1. Are You Using the Property as Your Chief Residence or as a Rental?

If you live in your property and then decide to rent it out, you will most likely lose the opportunity to claim any depreciation over the time you spent living in the property. However, there are Government incentives and grants that mitigate this, in which case you might not need to worry about depreciation at all.

2. How Long Are You Planning on Owning the Property?

The ATO determines the effective life of a property asset to be 40 years. If you have no intention of selling over this period, then the result of deprecation is the same. However, sometimes circumstances change. So, it is vital to keep this at the back of your mind.

3. What Does Your Income Look Like in the Future?

Suppose you are on a lower income at the time of purchase. In that case, you might be more likely to lower your tax deductions in the first few years of owning property to take advantage of increased tax depreciation claims later when you are earning a higher income.

4. Keep Inflation in Mind.

The cost of living seems to be on a continual upward trajectory. What $10 gets you today will not necessarily be what it gets you in a few years. Some investors prefer to claim any extra deductions they can claim as early as possible to allow them to use that extra money to invest.

Property Returns – Choose the Right Method for You

Both, the diminishing value method and prime cost method, have their benefits and shortcomings when you claim deductions, so there isn’t one best method. However, it is essential to realise that once you have chosen your strategy, you can’t change it! Property Returns can help you choose between prime cost vs diminishing value and ensure you get the best depreciation method and depreciation schedule to suit your cash flow and economic growth. Our expert team of tax practitioners and quantity surveyors will guide you through the value of your investment property and how it fits into your financial aspirations as an investor. If you are looking for more information on depreciation value and claiming depreciation on investment properties, expert advice on your tax depreciation schedule creation, or if you’re looking to get more out of your portfolio and make the most of your tax, get in touch with us today on our website or call us on 1300 829 221.