Building depreciation outlined

Depreciation provides a mechanism to recognise the economic decline in value of an asset as it is used to derive income. Depreciation does not represent a deduction for the cash cost of an asset, but is an allowance for loss in value. The government’s analysis of New Zealand building price data from 1993 to 2009 showed that, on average, buildings have been increasing in value.

On this basis, the ability to depreciate a building has been removed, starting from the 2011-12 income year. However, the depreciation recovery provisions remain intact, such that if a building has been depreciated in the past and that building is sold for more than its book value, any depreciation recovered will comprise taxable income.

The ability to apply to the IRD for a special depreciation rate based on the intended use of a building has also been removed. Taxpayers will only have the option of applying for a depreciation rate for a class of building if one has not already been set by the IRD.

As businesses approach their next financial year, attention is turning to how assets have been classified in the past for depreciation purposes. The distinction between what is part of a building versus what is internal fit-out is the focus of that attention. The IRD has provided some assistance in the form of Interpretation Statements IS10/01 and IS10/02, which were finalised earlier this year. IS10/01 sets out the IRD’s view on what parts of a residential rental property are not part of the building and therefore able to be separately depreciated. IS10/02 sets out the IRD’s view on what is a ‘building’.

In IS10/02 the IRD has referred to the reasonable person test (i.e. would a reasonable person consider a particular structure to be a building) and has advised the following characteristics are generally indicative of a building, i.e. the structure is:

  • of considerable size
  • permanent
  • fixed to the land on which it stands
  • enclosed by walls and a roof
  • able to function independently of any other structure, though it is not necessarily a separate physical structure.

To determine whether an item is part of a building or fit-out, the IRD has set out the following approach in IS10/01.

If it is unattached it will not form part of the building (e.g. carpet, curtains,hot water cylinders, freestanding storage units). An item is not considered attached if it is plugged or wired in (e.g. an oven).

If an item is attached to the building, is it either an integral part of the building or is it built in or attached in such a way that it is part of the fabric of the building (e.g. electrical wiring, tiles, plumbing).

Although this Interpretation Statement (IS10/01) applies only to residential properties, it can be reasonably assumed that the IRD will take a similar approach to commercial buildings. However, given the various purposes for which commercial buildings are used, and the alterations/additions applied by a tenant, different conclusions by comparison to the residential context are likely. Taxpayers are in some cases considering re-classifying assets and claiming depreciation based on altered rates. The IRD is expected to provide further guidance on this and other issues.

A further impact of the removal of depreciation is likely to be an increase in the use of deductions for repairs and maintenance to a building.

In the past, whether an expense could be claimed as repairs and maintenance or required to be capitalised and depreciated represented a timing difference. Going forward, some landlords may take an aggressive approach to repairs and maintenance as it represents the only means of deducting costs associated with a building. IRD scrutiny of repairs and maintenance claims is also likely to increase as a result.

Irrespective of whether a property is rented in a commercial or residential context, the inability to claim depreciation is likely to cause the taxable incomes of landlords to rise, and depending on how successful landlords are with their fit-out analysis and repairs and maintenance policy, it remains to be seen what the flow on effects to property prices and rents will be.

Published Summer 2010.

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