Capital Allowances: Rules, Claims & Depreciation

What are capital allowances?

Capital allowances are the tax rules that let you claim a deduction for the decline in value (depreciation) of capital assets you hold for producing assessable income. They cover depreciating assets (plant and equipment) and interact with separate rules for capital works deductions (structural building costs). Capital allowances differ from repairs and operating expenses because they apply to the capital cost of acquiring or constructing an asset, rather than to day-to-day maintenance.

• Depreciating asset: an asset expected to decline in value over time (e.g., machinery, office furniture, a commercial oven).
• Capital works: building costs, structural improvements or construction expenditure that produce a capital works deduction (often claimed over long statutory lives).
• Repairs vs capital: repairs restore an asset to its original condition — usually deductible immediately. Capital expenditure creates or improves an asset and is claimed under capital allowances or capital works rules.

For authoritative guidance, see the ATO's pages on Depreciation and capital expenses and allowances and General depreciation rules – capital allowances. Legislative text is in the New Business Tax System (Capital Allowances) Act 2001 Schedule 1: https://classic.austlii.edu.au/au/legis/cth/num_act/nbtsaa2001447/sch1.html.

Who can claim capital allowances?

You can claim capital allowances if you hold a depreciating asset and use it to produce assessable income. Typical eligible taxpayers include:

• Sole traders, partnerships and companies operating businesses.
• Trusts that hold income-producing assets.
• Property investors and landlords who own plant and equipment in rental properties.

Some exclusions or limits apply (for example, private or hobby assets, or assets used solely for private purposes). Entities using small business concessions may access simplified rules — see small business tax concessions and the ATO small business guidance.

What types of assets qualify?

Capital allowances apply across several categories. Knowing which bucket your asset sits in determines how you calculate deductions.

Plant and equipment

Examples include machinery, vehicles (business use), computers, office furniture and commercial kitchen equipment. These are depreciating assets claimed under capital allowances (decline in value). For vehicles and plant, consider whether the asset is a motor vehicle or plant for fringe benefits/tax rules.

Related reading: plant and equipment.

Capital works

Structural building costs, renovations, extensions and major fittings fixed to the building are claimed as capital works deductions on a statutory basis (usually over 25–40 years depending on the nature of the work). See capital works deductions and the ATO guidance above.

Low-cost and low-value assets

Low-cost assets have an acquisition cost under a small threshold and may be immediately deductible or pooled under simplified depreciation. Low-value assets with a value below the low-value threshold can be pooled or written off under certain rules. For small business, simplified depreciation rules and instant asset write-off/temporary full expensing influence these options — see instant asset write-off and temporary full expensing.

When does an asset start to decline in value?

An asset begins to decline in value for tax purposes from the earliest of:

• when the asset is first used to produce income, or
• when it is installed and ready for use (held ready for use), even if not yet used.

If you buy an asset and keep it unused, the decline in value starts when it is first held ready for use for income-producing purposes. For second-hand goods or part-year acquisitions, you prorate deductions based on the period the asset was held and used during the income year.

How to calculate decline in value (methods)

You can generally choose between two decline in value methods for depreciating assets: diminishing value (DV) and prime cost (PC or straight-line). Use the method that gives the best outcome, but be consistent and follow ATO rules.

Diminishing value method

Diminishing value calculates a percentage of the asset's opening adjustable value each year. In practice:

• DV deduction = Base value × (days held / 365) × DV rate
• DV rate for most assets = 200% ÷ effective life (or use the ATO table percentage)

Example:

• Commercial coffee machine cost $1,000 (GST exclusive), effective life = 10 years.
• DV rate = 200% / 10 = 20%.
• Year 1 full-year deduction = $1,000 × 20% = $1,600.
• For part-year purchases multiply by days held/365.

Prime cost method

Prime cost spreads cost evenly over the effective life:

• PC deduction = Cost × (days held / 365) × (100% ÷ effective life)

Example:

• Same coffee machine $1,000, effective life 10 years.
• PC rate = 100% / 10 = 10%.
• Year 1 full-year deduction = $1,000 × 10% = $100.

Choosing a method

• DV provides larger deductions in early years — good for assets that quickly lose value.
• PC gives even deductions — useful for budgeting and long-life assets.
• You can change methods in some circumstances but must follow ATO rules and keep records of any change.

Comparison summary:

Effective life and determining asset life

Effective life is the period over which an asset declines in value. The ATO publishes effective life tables you should consult first: ATO — Effective life of depreciating assets. You may self-assess effective life if you have reasonable grounds — document the basis.

Low-cost and low-value asset rules

Thresholds and pooling rules allow small businesses to immediately deduct or pool low-cost/low-value assets:

• Low-cost threshold: assets under a set dollar amount may be immediately deductible (check current ATO figures).
• Low-value pooling: assets under the low-value threshold can be pooled and depreciated at a set pool rate.
• Small business simplified depreciation: eligible small businesses may use an instant asset write-off or temporary full expensing for qualifying assets — refer to ATO guidance.

Note that temporary full expensing rules are time-limited and have eligibility criteria — check current ATO guidance before claiming.

Interaction with tax incentives and concessions

Capital allowances interact with several incentive measures:

• Temporary full expensing / immediate write-off: If eligible, you can deduct the business portion of the cost of an eligible depreciating asset in full in the year of first use. These rules generally replace standard depreciation for that asset but have strict eligibility, turnover and timing tests. See the ATO guidance and instant asset write-off and temporary full expensing.
• Small business simplified depreciation rules: Small businesses meeting turnover thresholds may access pooling, lower thresholds and immediate deductions.
• Accelerated depreciation measures: Time-limited measures (e.g., investment incentives) may interact with capital allowances; confirm current laws and dates.
• Second-hand assets: Second-hand depreciating assets generally qualify, though instant write-off eligibility and effective life issues may differ.

When financing asset purchases via equipment finance or asset finance, you still claim depreciation based on ownership/usage for tax purposes. Financing method does not change the capital allowance entitlement.

Disposal, change in use or cease use of depreciating assets

When you dispose of or stop using an asset for taxable purposes, a balancing adjustment may arise:

• Calculate the difference between the asset's termination value (sale proceeds) and its adjustable value (written down value).
• If proceeds > adjustable value → balancing adjustment included as assessable income.
• If proceeds < adjustable value → additional deduction.

Example:

• Original cost $10,000, accumulated deductions $1,000 → adjustable value $1,000.
• Sold for $1,000 → balancing adjustment = $1,000 assessable.

Report balancing adjustments in the relevant tax return year and keep sale documents as evidence.

Record keeping and evidence required

Good records are essential. The ATO expects reliable records to substantiate your claims.

Minimum records checklist

• Tax invoices/receipts for purchases (GST exclusive where applicable).
• Purchase contracts and finance agreements.
• Date asset was first used or ready for use.
• Depreciation schedule showing method, effective life and annual deductions.
• Logbooks for vehicles (business use %).
• Disposal documents (sale contract, receipt) and calculation of balancing adjustment.
• Evidence of eligibility for small business concessions or temporary full expensing.

Retention periods: keep records for at least five years from the date you lodge the relevant tax return, or longer for certain assets/arrangements. See ATO — Record keeping for businesses and record keeping for businesses for more.

Common record-keeping mistakes

• Missing or incomplete invoices.
• No record of date ready for use.
• Failure to document self-assessed effective life.
• Mixing private and business use without logbooks.

Step-by-step: How to claim capital allowances on your tax return

1. Identify depreciating assets acquired or used during the year.
2. Classify assets: plant & equipment vs capital works vs low-value/low-cost assets.
3. Determine effective life: use ATO tables or self-assess with documentation.
4. Choose method: diminishing value or prime cost (check eligibility and consistency).
5. Calculate decline in value: apply formulas with days-held adjustments.
6. Consider incentives: check eligibility for temporary full expensing or small business rules.
7. Prepare depreciation schedule: opening adjustable value, deductions, closing value.
8. Record disposals: compute balancing adjustments and retain sale documents.
9. Complete return: include deductions on the business or rental property schedule.
10. Retain supporting records: keep invoices, schedules, and evidence for audits.

For tax agents or BAS agents preparing returns, ensure the depreciation schedule aligns with tax lodgment software and that clients' turnover/eligibility information for concessions is current.

Worked examples

Example 1 — Small business buys machinery (Diminishing value)

• Asset: CNC machine, cost $120,000 (GST exclusive), purchased 1 Sep, used immediately.
• Effective life (ATO table): 10 years. DV rate = 200% / 10 = 20%.
• Days held in year 1 = 122/365.
• Year 1 deduction = $120,000 × 20% × 122/365 = $1,032 (rounded).
• Closing adjustable value = $120,000 − $1,032 = $111,968.

Example 2 — Investor fits out rental property (Prime cost)

• Asset: Kitchen appliances & fixed cabinets, cost $10,000, effective life 15 years.
• PC rate = 100% / 15 = 6.6667%.
• Full year deduction = $10,000 × 6.6667% = $1,000.
• If eligible for small business immediate write-off (and rules apply), the investor may instead claim an immediate deduction — check ATO timing and eligibility.

Example 3 — Disposal balancing adjustment

• Asset original cost $10,000, accumulated depreciation $15,000 → adjustable value $15,000.
• Sold for $18,000 → $1,000 balancing adjustment included as assessable income.

Common mistakes and pitfalls

• Misclassifying capital works as plant and equipment (or vice versa).
• Using the wrong effective life or failing to document self-assessment.
• Overlooking part-year apportionment for assets purchased or sold during the year.
• Ignoring eligibility conditions for temporary full expensing or instant asset write-off.
• Poor record keeping (missing invoices, dates, or disposal documents).

FAQ

Key takeaways

Capital allowances let you claim tax deductions for the decline in value of depreciating assets; capital works deductions cover building-related costs. Decide whether an item is plant and equipment or capital works, determine effective life, choose diminishing value or prime cost (or check for immediate write-off eligibility), and keep clear records. Check ATO guidance and confirm current thresholds and time-limited incentives before claiming. When in doubt, get tailored advice from a registered tax agent.

Further reading

• ATO — Depreciation and capital expenses and allowances: https://www.ato.gov.au/businesses-and-organisations/income-deductions-and-concessions/depreciation-and-capital-expenses-and-allowances
• ATO — General depreciation rules – capital allowances: https://www.ato.gov.au/businesses-and-organisations/income-deductions-and-concessions/depreciation-and-capital-expenses-and-allowances/general-depreciation-rules-capital-allowances
• ATO — Effective life of depreciating assets: https://www.ato.gov.au/business/depreciation-and-capital-expenses-and-allowances/effective-life/
• New Business Tax System (Capital Allowances) Act 2001 Schedule 1: https://classic.austlii.edu.au/au/legis/cth/num_act/nbtsaa2001447/sch1.html

This article is general information only and is not legal, tax or financial advice.