What is the Effective Life of Depreciating Assets?

You can determine a depreciating asset’s effective life by checking out how long the asset can be used for a taxable purpose by an entity. In today’s blog post, we’ll discuss the basics of depreciating asset’s effective life along with other important aspects.

Overview of Effective Life of Depreciating Assets

The effective life of a depreciating asset refers to the time period during which it can be used by any entity for a taxable purpose. It also includes the time period for which it can be used for producing exempt income or non-assessable non-exempt income.

• The calculation of effective life takes into account the expected wear and tear under normal usage conditions.
• Assuming that the asset will be maintained in good condition.
• It also considers the estimated period until the asset is scrapped, sold for no more than scrap value or abandoned.

Effective life can be shown in years, including fractions of years, and it will not be rounded to the closest whole year.

Determining Effective Life

For most depreciating assets, you can check out the effective life yourself or the Commissioner can work out the effective life. You need to make a choice for the income year in which the start time of an asset occurs. Basically, you can make a choice by the time you file your income tax return for that year. However, the choice is not available:

• for most intangible depreciating assets
• if a depreciating asset was obtained from an associate who could have claimed or has claimed deductions for the asset’s decline in value
• when you hold a depreciating asset, and the asset’s user remains the same or is an associate of the former user, for instance, in a sale and leaseback arrangement
• in case there has been rollover relief.

Checking Out the Effective Life Yourself

You can check out the effective life yourself by checking out how many years it will be expected to generate income given the particular way it intends to be used. The type of information that you could use to estimate the effective life of an asset includes:

• the asset’s physical life
• engineering information
• the specifications of a manufacturer
• your experience with similar assets
• other users’ past experience with similar assets
• the level of maintenance and repairs commonly adopted by users of the asset
• retention periods
• scrapping or abandonment practices.

Commissioner’s Determination

When deciding, the Commissioner assumes that the asset being depreciated is new. The Commissioner also considers the general industry circumstances of use. As a general rule, it is advised to use the current version of the Taxation Ruling or schedule that is in force at the time you:

• enter into a contract to obtain the asset
• otherwise, obtain the asset, or
• begin to construct the asset.

However, the start time of an asset doesn’t occur within 5 years of this time, you need to make use of the effective life that is in force at the start time of an asset. For an item of the plant obtained under a contract entered into, otherwise obtained or started to be built prior to 11:45 am AEST on 21 September 1999, there is no restriction on the time within which the plant is used.

Recalculate Effective Life

You can recalculate the effective life of an asset if a situation changes and the effective life you have been using is no longer correct. You must recalculate the asset’s effective life if you improve an asset that maximises its cost by 10% or more in a year. If you recalculate the depreciating asset’s effective life, the new effective life will start to apply to the income year for which you recalculate. If you use the declining value method to check out the decline in value of a depreciating asset, you use the new estimate of effective life in the formula.

Conclusion

It is important to determine the effective life of depreciating assets yourself or by commissioner. Moreover, if you need assistance with your depreciating asset’s effective life, you can also receive support from Reliable Melbourne Accountants.

More Useful Links:
Small Business Accountants
Tax Agent Melbourne