I haven’t met anyone who thinks that the money they’ve just spent on their rental property isn’t deductible for income tax.
Well, the costs of the plumber and the electrician to keep everything in good working certainly are. But for major expenditure on residential properties it may be different.
In 2012 there were some changes to the tax law affecting property and the taxation of profits from rents. In that year Inland Revenue published an Interpretation Statement setting out its views on what was deductible and what wasn’t.
Bedtime reading it isn’t as it runs into 55 pages and one senses the input of lawyers. Nevertheless it’s a comprehensive statement of the department’s view of the law on property expenditure and you can’t ignore it.
Many New Zealanders buy a run down property to renovate and let. But if you spend money on the property before you let it, the expenditure may not be deductible. Inland Revenue’s 2012 statement confirms the “dilapidation repairs” situation, saying that this sort of expenditure is likely to be treated as part of the cost of the property. If the expenditure is significant, and necessary to remedy defects you knew were present when you purchased, the expenditure could be called “dilapidation repairs” and treated as a capital cost. Before 2012 you may have been allowed depreciation on your expenditure to give you a tax benefit spread over several years. But not today.
In 2012 the government clamped down on the tax positions of many property-owning taxpayers who were claiming depreciation and interest deductions to create a loss. The loss was then deducted from other income which in many cases gave tax refunds. From 2012 depreciation allowances on buildings have not been allowed – that’s what’s different.
The Interpretation Statement was fairly clear when it said that expenditure incurred soon after purchase is likely to be considered part of the purchase price, and therefore non-deductible. So when you “buy cheap” and “spend up big” to bring a property up to an acceptable standard before letting, your expenditure probably isn’t deductible. Not will the expenditure qualify for a depreciation allowance. Some commentators have called it “black hole expenditure”.
But there may be a glimmer of hope. As is often the case in income tax matters, each situation must be considered on its merits.
The key issues to consider are:
1. Could the property be let (in spite of its defects) at the time of purchase?
2. Is the value of the property improved by spending the money?
3. What is the scale of the work relative to the value of the asset being “repaired”? The sum of $10,000 spent on a dwelling might be considered differently to $10,000 spent on a stand-alone garage.
If the property can’t be let until the repairs are completed, or if the cost of the repairs is relatively high compared with the value of the whole (the “scale” aspect), you are probably out of luck. Inland Revenue would say the price you paid allowed for the defects, and your repair costs simply bring the total expenditure up to a fair price for the property. The old “dilapidation repairs” rule would apply and there would be no deduction.
But if the property could be let when bought, even with its defects, and the cost of the repairs is relatively small, it might be possible for the repairs to be deductible. It helps if you can show that the value of the property was unaffected by the work. And as I said, it all depends on the facts of the case.
Far North Tax Professionals
23 November 2017