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Depreciation clause depresses taxpayers

In Budget 2010, the Government introduced changes to the depreciation rate of buildings used in earning rental income

The depreciation rate for buildings with a life span of 50 years or more has been set at 0% affecting the tax claim by property investors.

However, the depreciation rate for items used, but not part of these buildings normally called ‘chattels’ remains unchanged and these items will continue to be depreciated separately from the building itself.

A summarised position with regard to depreciating rental properties for tax purposes is as follows: For the residential rental property, Inland Revenue Commissioner has issued an interpretation statement.

“Residential rental properties – depreciation of depreciable assets (IS 10/01), clarifying as to how to determine whether an item in the residential rental property is a part of the building or separately depreciable. Indian Newslink, November 1, 2010).

The Interpretation Statement (IS 10/01) essentially provides that for a residential property, an item should be included as a part of the building if (a) there is a degree of physical attachment to the building (b) the item is integral to the building’s function and completeness; and (c) there would significant “impact” on the building’s fabric if the item was removed.

Based on this approach, as per the directives of the Inland Revenue Department (IRD), the following items are not separately depreciable in a residential property:

Plumbing and piping, electrical wiring, internal walls, internal and external doors, garage doors (if the garage is part of the residential rental building), fitted furniture (wardrobes and cupboards built into the wall), kitchen cupboards, bathroom fittings and furniture, linoleum and tiles (wall and floor).

Inappropriate Tests

The application of the above tests to non-residential property is not appropriate.

There is a constant pressure on building owners to upgrade the fit-out in a non-residential property. The non-residential fit-out is generally less permanent than residential fit-out due to specific requirements of tenants and changes of use.

Appreciating this, IRD has proposed a different approach to non-residential building fit out.

It’s Policy Advice Division and the Treasury have released an Officials’ Issue Paper outlining their approach.

This approach would be applicable only to non-residential buildings and not to residential buildings. Such buildings would encompass a dwelling that would include any building, premises or structure including any parts of these items being used predominantly as a place of residence or abode for any individual. But it will not include a commercial dwelling such as hotels, motels, rest homes and hospitals.

Mixed Purpose

Where there is a mixed purpose building fit out, the officials have suggested “a Dominant Purpose Test”. Where there is a mixed used buildings that have shared fit-out items (such as lifts and electrical reticulation), the taxpayer will be entitled to separately depreciate any shared fit-out items, if the dominant purpose of the building is to provide non-residential space.

For example, a multi-storey commercial office building may have a penthouse apartment with a dominant purpose of providing commercial space.

As per the IRD paper, items of non-residential building fit-out could be separately depreciated if the items is described in the Commissioner’s depreciation determination asset category “Building Fit-out”, or if the item is a plant.

Where the plant is integrated into the fabric of the building, it can also be separately depreciated at the appropriate depreciation rate.

For instance, wool-scouring plant may be integrated into the fabric of the building but would be still depreciable.

Transitional Rules

The above issues paper also proposes a transitional rule for those taxpayers owning commercial and industrial fit-out as part of the building.

These transitional rules allow taxpayers who have not separately identified items of fit-out in non-residential buildings to create what is essentially a notional fit-out pool.

These taxpayers would be able to create a building depreciation pool of 15% of the building’s adjusted tax book value, which would then continue to be depreciable at 2% per annum. This pool would be referred as the “Non-Residential Fit-Out Pool.”

There will be no depreciation recovery income or loss on disposal of the fit-out pool.

Taxpayers will have one opportunity to elect into the pool- by adopting the pool approach in their income year starting from April 1, 2011.

IRD rules say that the building structure in a non-residential property would include the foundations, the building frame, floors, external walls, cladding, windows and doors, stairs, the roofs, load bearing structures such as pillars and load bearing internal walls.

As such, these will be treated as a part of the building and would not be eligible for depreciation if the estimated life of that building were 50 years or more.

This provision will come into force on April 1, 2011.

The items of fit-out that would be separately depreciable have been provided in the Commissioner’s Building Fit-out Asset category.

There would not be any change to the rates of depreciation for these items.

Items that are not contained in this list and are not a part of the non-depreciable building structure mentioned above would continue to be depreciable at the default rate.

Claiming of depreciation could be a daunting issue for property investors and hence they are advised to seek professional advice going forward.

Vijay Talekar is Director, Tax Experts Limited (Chartered Accountants), based in Auckland. The above article should be considered only as a guideline and not specific advice. Mr Talekar absolves himself along with the management and staff of Tax Experts Ltd and Indian Newslink of any responsibility or liability that may arise from the above article. Readers should seek professional advice before acting upon any information contained above.

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