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Depreciation & The Horse Industry - Faq's - Jan 2005

 Without doubt, depreciation is one of the most misunderstood areas of tax law and I'm not the only accountant that will tell you that.

So, after 10 years of writing articles for this worthy publication, at last I devote an article to this topic and its practical application to many horse industry issues.

The whole area of depreciation has been further complicated in the past few years by the introduction of the "pooling" system to what the ATO designates as a "small business". This area gets special attention in this article.

This article commences with a general overview of depreciation rules and then addresses "Frequently Asked Questions" that my office receives in relation to depreciation and "racing" and depreciation and 'breeding".


1. What is Depreciation?

The best way of explaining depreciation is that it is a way of systematically claiming a deduction for the decline in value of a "depreciating asset" within an income producing business.

A "depreciating asset" is an asset that has a limited effective life and is reasonably expected to decline in value over the time it is used in a business. As a "rule of thumb", a depreciating asset will generally be used by the business for greater than 12 months after acquisition. These contrast with ordinary business expenses that are fully utilised within 12 months of incurring the expenditure, for example advertising, rent, stationery, service fees, selling expenses etc. Accordingly, these expenses are 100% deductible in the year of purchase.

In a horse racing and/or breeding business a "depreciating asset" would typically be:

  • Computers;
  • Fencing;
  • Desks;
  • Racehorses (not breeding stock!);
  • Stabling;
  • Water troughs; and
  • Tractors and other farm vehicles.


2. Other depreciation ground rules

Other important rules relating to depreciation are:

Depreciation cannot be claimed until the horse business has commenced.

Example

A breeder buys a property that has poor fencing. Before any stock can be placed on it, all fencing is gradually replaced.

As no stock is being run on the property in this replacement phase, the ATO would deny any claim for fencing depreciation. In effect, the business has not "commenced".

  • Depreciation cannot be claimed for assets that are used only for "private" purposes.

Example

A breeder buys a desk for his home office and another desk for his child's bedroom. Depreciation cannot be claimed on the child's desk as it is not used for the horse business.

  • Depreciation is allowed for assets used partly for business purposes.

Example

A breeder always studies stallion promotional videos very closely prior to making a choice for a particular breeding season.

As the breeder uses his DVD player and television for this purpose, the ATO will allow a partial claim for depreciation of these items.

  • Generally, the depreciation rate for an asset is based on the "effective-life" of the asset and is set by the ATO (unless you want to elect to self-assess the "effective-life").


3. What is the "cost" of an asset?

Depreciation represents a deduction for the decline in value relating to the "cost" of an asset. The concept of "cost" is not as simple as what you may think.

Generally, the cost of an asset is what you pay for it. NB. If you claimed back the GST when you bought it, it is the "GST exclusive" value. However, it is not well known that the cost of an asset also includes the cost incurred to start "holding" the asset and also to "bring it to its present condition and location".

Example

Nick runs a business of racing and breeding and imports a well bred "Storm Cat" yearling colt to Australia, his purchase price AUS$500,000. Freight to Australia costs AUS$30,000. The freight is not immediately deductible as it is considered by the ATO as a cost incurred to bring the colt "to its present condition and location". Hence the "cost" of the colt to be depreciated is inclusive of the freight, i.e. $530,000.

"Cost" for assets that are constructed?

If a depreciable asset is constructed, the total of the constructions costs are "merged" into the one "cost".

Example

Kim the breeder builds impressive "post and rail" fencing for her horse holding yards. The fence is constructed over a one-month period and materials and labour are paid for on a weekly basis. Accordingly, the "cost" of that fence for depreciation purposes is the total of all those costs.

NB. The labour is not deductible immediately as it is incurred as part of the "installation" cost of the fence.
 

4. New "pooling" rules for "Small Businesses"

The new "pooling" rules have only been introduced in the past few years and are of great benefit to a "small business" breeder as they provide an accelerated form of depreciation to business assets.

To be eligible for these concessions, the small business breeder must, amongst other things, have an average turnover in their business of less than $1 million dollars and have elected to be part of the new "Simplified Tax System" ("STS").

How does the "pooling" system work?

The general rules are:

  • Assets costing less than $1,000 are immediately deductible.

Example

Julie the breeder buys special breeding software for $850 (excl GST). As a small business breeder who has elected to be in the STS, Julie can claim a 100% deduction for this software.

  • A "General STS pool" for assets with an effective life of less than 25 years. These assets can be depreciated at 30% p.a. and 15% for the year that they are acquired.

Example

A farm tractor is acquired for $20,000 (excl GST) on 1 January 2004. Under these rules, 15% of its cost can be deducted in year 1 and 30% p.a. in subsequent years.

  • A "Long Life STS pool" for assets with an effective life of greater than 25 years. These assets can be depreciated at 5% p.a. and 2.5% for the year that they are acquired.

Example

Freda the breeder constructs a dam on her breeding property. Under the "Long Life STS pool" rules, 2.5% of the cost is deducted in year one, 5% p.a. in subsequent years.

NB. In this instance, I would not suggest that Freda uses this pool as under special "primary production" rules, she can write-off the dam construction at 33.33% p.a. As a primary producer, Freda can choose which method is best for her.

5. New "pooling" rules for other businesses

If your business is not a "small business" it can elect to use the new "Low-Value" pool provisions.

Under these rules:

  • An asset costing or "written-down" to less than $1,000 can be depreciated at 18.75% in the year of purchase and 37.5% p.a. for subsequent years.

Example

Mario the breeder does not qualify as a "small business" (see rules above) and buys a second-hand computer for keeping his horse records. Cost of the computer was $800 (excl GST). Under the "low-value" rules, Mario can write-off the computer at 18.75% in year 1 and 37.5% thereafter.


6. Depreciation and Horses - FAQs

RACING

Can I depreciate a racehorse?

Answer:

If you are in the business of racing, yes. The current ATO rate is 10% p.a. prime cost, 15% diminishing value.

However, if the primary reason that you are keeping the racehorse is to sell the horse when the opportunity arises, the racehorse would then be treated as "trading stock" and depreciation is not allowed.

Q2. At what age can I begin depreciating a racehorse?

Answer:

Per an ATO taxation ruling, from the age of 2 years.

Q3. If a racehorse that I was depreciating is retired and given away as a "hack", what are the tax implications?

Answer:

The remaining "written-down" value becomes a tax deduction. For example, if a horse is acquired for a cost of $30,000 and been subjected to $20,000 of depreciation during its career, its "written-down" value is $10,000 ($30,000 less $20,000). Accordingly, the $10,000 becomes a tax deduction.

NB. If $500 was received for this horse, the tax deduction is reduced to the extent of the sale money received, i.e. $9,500 ($10,000 less $500 sale proceeds).


6. Depreciation and Horses - FAQs

BREEDING

Q4. Can I depreciate a broodmare?

Answer:

Strictly speaking, no. Mares are "trading stock" and cannot be "depreciated". However, under trading stock rules, eligible mares can be "written-off" under the "special closing value" rules.

Q5. If I'm a breeder and race a filly before I use her for future breeding, can I depreciate her whilst she is racing?

Answer:

No, on the basis that the primary purpose that you are keeping her is that you wish to "sell the horse or its bodily produce including any progeny".

Q6. I have just bought a property and want to depreciate the sophisticated and costly fencing. What "cost" do I use for this fencing as its "cost" was not specified in the contract?

Answer:

A person will generally need to make his or her own reasonable apportionment. In making this estimate, it is expected that the person would generally have regard to, and be able to justify, his or her reasonable apportionment based on the relevant market value of the fencing at the time of the making of the contract.

It is important to note that, in recent audit activity, the ATO has required the apportionment to be made by a qualified person, although this is not apparent in the tax law.

It should be noted that the "written-down" values of depreciable assets are not necessarily their market values.

You are welcome to contact me if you wish me to clarify or expand upon any of the matters raised in this article.

 


PAUL CARRAZZO CPA
CARRAZZO CONSULTING CPAs
22 BLACKWOOD ST, NORTH MELBOURNE VIC 3051
PH: (03) 9329 7044
FAX: (03) 9329 8355
MOB: 0417 549 347
Email: This e-mail address is being protected from spambots. You need JavaScript enabled to view it

 

DISCLAIMER
Any reader intending to apply the information in this article to practical circumstances should independently verify their interpretation and the information’s applicability to their particular circumstances with an accountant specialising in this area.

 

Reproduced with permission from the Australian Bloodhorse Review © Copyright 2005

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