Depreciation explained: Tax benefits and how it impacts your business

Published Tuesday 23 December 2025

Table of contents

• What is depreciation?
• Purpose of depreciation: 3 main functions
• What can be depreciated?
• Methods of calculating depreciation
• ATO depreciation schedules and rates
• Depreciation for small business
• FAQs on depreciation

Key takeaways

• Apply depreciation accounting to spread asset costs over their useful life, ensuring your profit and loss statements accurately reflect true business costs rather than overestimating profits.

• Utilise ATO depreciation schedules and rates to claim legitimate tax deductions on fixed assets like equipment, vehicles, and computers, potentially reducing your tax bill significantly.

• Implement accounting software like Xero to automate depreciation calculations and maintain accurate asset registers, eliminating manual errors and ensuring compliance with tax requirements.

• Recognise that depreciation directly impacts your business valuation and borrowing capacity, as banks use depreciated asset values when assessing loan security and financing options.

What is depreciation?

Depreciation is the accounting method that spreads the cost of a business asset over its useful life as the asset loses value. A work computer, for example, gradually depreciates from its original purchase price down to $0.

Why it matters: Depreciation techniques help you measure declining asset values and record them accurately in your business books. This area of accounting can get complex, so it’s wise to work with a professional.

Purpose of depreciation: 3 main functions

Depreciation accounting serves three key functions for your business:

• Cost accuracy: Helps you understand the true cost of doing business by accounting for wear and tear
• Tax benefits: May reduce your tax bill through legitimate deductions
• Business valuation: Provides accurate estimates of your business’s current value

1. Depreciation as an expense (cost of doing business)

Depreciation as a business expense reflects the reality that assets wear down and need replacement. This makes depreciation a legitimate cost of doing business.

How it works: Depreciation accounting calculates how much value your assets lost during the year. This amount appears on your profit and loss statement and reduces your calculated profit.

Why you need to record depreciation Without accounting for depreciation, you’ll underestimate your true costs and overestimate your profits.

You can download our free P&L template so that you can work out all of your costs.

2. Depreciation and tax

Tax depreciation allows you to gradually claim an asset’s entire value as a tax deduction. For instance, small businesses can pool the business portion of higher-cost assets, claiming a 15% deduction in the first year and 30% in subsequent years, potentially reducing your tax bill significantly.

Important tax rules

• Timing rules: Specific regulations govern how quickly you can depreciate different asset types
• Professional advice: Always consult your accountant or the ATO for asset-specific depreciation rules
• Compliance: Following proper depreciation schedules ensures you maximise tax benefits legally

3. Valuing your business (depreciation on the balance sheet)

Asset depreciation directly impacts your business valuation. A transport company with new trucks is typically worth more than one with old trucks.

Balance sheet impact:

• Fixed asset register: Lists all your assets on the balance sheet
• Regular updates: Update asset values each time you calculate depreciation
• Accurate valuation: Keeps your business valuation current and realistic

Financing considerations:

• Loan security: Banks often use assets as loan collateral
• Reduced borrowing power: Depreciated assets provide less security for loans
• Planning ahead: Monitor asset values to anticipate financing limitations

Download our free balance sheet template to help you keep track of your assets.

What can be depreciated?

Not all tax-deductible expenses can be depreciated – there’s an important difference between these two concepts.

Immediate deductions:

• Consumables: Items like stationery must be claimed in the year of purchase
• Operating expenses: Most day-to-day business costs are immediately deductible
• Timing: These expenses are claimed once, in full, during the purchase year

Depreciable assets: Only fixed assets that provide long-term business value can be depreciated over time.

What are fixed assets?

Fixed assets are items that help generate business income for more than one year.

Physical fixed assets:

• Equipment: Tools, machinery, computers, office furniture
• Vehicles: Cars, trucks, and delivery vehicles. It’s important to note the ATO sets a limit on the value that can be depreciated for cars; the car limit for 2024–25 is $69,674.
• Property: Buildings (but not land, which doesn’t depreciate)
• Ownership: You can depreciate some leased items too

Intangible assets:

• Intellectual property: Patents, copyrights, trademarks
• Value decline: These assets lose value as they approach expiry dates
• Amortisation: The process for intangible assets (similar to depreciation)

Non-depreciable items:

• Land: Doesn’t lose value, so can’t be depreciated
• Inventory: Handled separately under inventory accounting rules

Methods of calculating depreciation

You also need to decide how an asset’s value will decline over its lifespan. Will it lose most of its value early, or will it lose value at the same rate every year? There are several methods of calculating depreciation.

Some are more detailed than others, but you only need to choose the one that fits your business. Three of the most common are:

Straight line depreciation

Under this method, the asset depreciates the same amount every year, till it has zero value. For instance, an asset expected to last five years would depreciate by one-fifth of its ticket price each year.

Diminishing value depreciation

Under diminishing value depreciation, an asset loses a higher percentage of its value in the first few years. That rate of depreciation gradually slows down as time goes on.

Units of production depreciation

The lifespan of some assets is better measured by the work they do than by the time they serve. For example, a vehicle might travel a certain number of kilometres, or a packaging machine might box a certain number of products. You could depreciate these assets based on usage rather than age.

ATO depreciation schedules and rates

Asset lifespan estimation is the first step in depreciation calculation. Different assets have vastly different useful lives.

Lifespan examples:

• Computers: Typically 3-4 years
• Industrial equipment: Often 20-30 years
• Vehicles: Usually 5-8 years

ATO guidance:

• Official schedules: The ATO provides depreciation schedules for most asset types
• Common practice: Most small businesses follow ATO recommendations, especially if they are eligible for the simplified depreciation rules, which apply to businesses with an aggregated turnover of less than $10 million.
• Compliance: Using official schedules ensures tax compliance

Asset disposal:

• Early write-off: You can write an asset’s value down to zero if it is lost, stolen or damaged
• Disposal options: You can sell, trade or combine assets into new assets

Depreciation for small business

Depreciation can seem tricky at first, but once you understand the basics it becomes straightforward. It will help you better understand your costs and may lower your tax bill. It doesn’t have to be complex either.

Most businesses simply adopt the depreciation schedule provided by the ATO. Once you set it up in accounting software like Xero, the software calculates depreciation automatically. The numbers then flow straight through to your financial reports and tax returns.

An accountant or bookkeeper can provide advice along the way, and you can get started today and try Xero for free.

FAQs on depreciation

Here are answers to some common questions about depreciation.

What are the four main types of depreciation methods?

The four most common methods are straight line depreciation (even depreciation each year), diminishing value (more depreciation upfront), units of production (based on usage) and sum-of-the-years’ digits (another accelerated method). The best one depends on the asset and your business needs.

What is the $300 depreciation rule in Australia?

For the 2024-2025 income year, the instant asset write-off threshold allows eligible businesses to claim an immediate deduction for costing less than $20,000. This simplifies bookkeeping for many purchases, as you don’t need to track their depreciation over several years.

Can I change my depreciation method once I’ve started?

Generally, once you choose a depreciation method, you must stick with it for that asset. However, the ATO has provided some flexibility, and the 5-year 'lock out' rule that stopped businesses from re-entering the simplified depreciation regime is suspended until 30 June 2025. It’s still best to consult with an accountant before making a change.

Do I need accounting software to manage depreciation?

While you can use spreadsheets, accounting software makes managing depreciation much easier. It automates complex calculations, reduces the risk of errors, and keeps your asset register up to date, saving you time and helping you stay compliant.