Why do rich people borrow money for depreciating assets and pay less tax?

depreciating asset

Economist are renowned for advising to never buy a depreciating asset using your business cash.   Assets have a window of time to generate income and help improve a business performance.

In terms of personal finance, it is a ‘cardinal sin‘ to borrow money for the purchase of cars and depreciating assets.  But if you use your car for business purposes or your business is purchasing equipment, lending the money is ‘saintly‘.  If you buy a depreciating asset like a car or equipment for your business, lend the money in a form of a Chattel Mortgage or Equipment Loan.  This frees up business cash reserves for utilisation in other areas and provides opportunities for tax benefits.

Depreciating assets are assets that decrease in value over its lifetime like a truck.  The life cycle is capped.  Usually they will be worthless over a certain time period.  These are unlike investments such as Term Deposits that increase and improve an overall financial position.     

Depreciating asset
Mining Equipment hard at work

Example of Depreciating asset

You buy a new truck for your business.  You spend $100K to buy the truck.  Whether you use cash or borrow the money in the form of an equipment loan the purchase of the truck is then capitalised as an asset on the business balance sheet.   Immediately after purchase the truck value is reduced.   Generally the more you use the vehicle the lower the value. Once in operation there will be ongoing maintenance, running and repair expenses.

Why is it ok to lend the money for Depreciating assets in your business?

You borrow the money in the form of either an Equipment Loan/ Chattel Mortgage or Lease for a new business asset.  Regardless of the repayments, your new purchase will depreciate faster than your loan repayments.  With vehicles a general rule is 4 – 7-year time frame for majority of the depreciation. 

Another lucrative factor for a business to lend the money is that the depreciation on the asset and the interest charged on the loan is a tax deduction.  It is a legal expense displayed on the profit and loss statement.  

Example of Straight-line Depreciation Schedule of new $100K Truck

Joe Blow Logistics Pty Ltd purchases a new truck at the beginning of the financial year for $100K.  The company’s accountant has estimated the life cycle of the truck to be 5 years with a salvage value of $25K.  The annual straight-line depreciation expense will be $15K.

Straight-line depreciation expense= $100K – $25K/5 = $15K

The straight-line depreciation schedule is shown below:

 Value at the beginning of the yearAnnual Straight-line Deprecation ExpenseAccumulated depreciation at the end of the yearValue at the end of the year
Year 1$100K$15K$15K$85K
Year 2$85K$15K$30K$70K
Year 3$70K$15K$45K$55K
Year 4$55K$15K$60K$40K
Year 540K$15K$75K$15K
Straight-line Depreciation

At the beginning of year 1, the value of the truck is $100K. After Year 1, the straight-line depreciation is nominated to $15K, with the value of the truck being $85K.  Year 2 will have another straight-line depreciation expense of $15K.  This will accumulate total depreciation to $30K leaving truck valued at $70K.   The same calculation continues for the life cycle of 5 years resulting in salvage value of $25K.

depreciating asset
Depreciation

For details regarding depreciation refer to the Australian Tax Office website or engage a registered tax agent or accountant. 

Like the rich, make your money make you money.  Borrowing for depreciating assets is one habit of the Rich.  Be money smart!  Learn how to legally reduce your tax!  For more information regarding lending money for depreciating asset like a car or equipment for your business contact Will Finance or make an enquiry today.

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