IRD may hit commercial fit-outs

Bayleys Valuations director John Freeman. Photo / Supplied

The Government has embarked on a path to abolish building depreciation on virtually every building type and could hit depreciation claims on commercial building fit-outs in future, says Bayleys Valuations director John Freeman.

Freeman says the Government's firm view, clearly reinforced in last week's Budget, is that New Zealand buildings do not drop in value over time and depreciation allowances therefore give property owners tax preferences.

Effective from the 2011/2012 income year, depreciation deductions will no longer be allowed for buildings with "an estimated useful life of 50 years or more".

"The tax depreciation rate effective for most property investors on buildings from April 1, 2011, will be reset to zero," says Freeman. "That is unless in accordance with IR 265 [the IRD's tax depreciation rate guide] a portable building is owned or one with prefabricated stressed-skin insulation panels. Owners currently having a building that meets this 'less than 50-year-useful-life' criteria can continue to depreciate at the current rate."

Freeman says the Government acknowledges that some property owners may feel their properties are in a class that has a useful life of less than 50 years.

"There is an option for property owners to apply to the IRD for a provisional depreciation rate in such cases and there may be quite a few of these rulings applied for by commercial real estate owners," he says.

The Budget indicated that repairs and maintenance costs to keep properties in good condition to maintain their value would still be allowed to be claimed. For the time being, depreciation claims on commercial building fit-outs and services not currently designated as buildings, will also be allowed, says Freeman.

"However, the Budget clearly stated that the Government will review the treatment of commercial property fit-outs and, if necessary, amend the rules on such allowances prior to April 1, 2011. It is thought this will clarify any uncertainty as to what property owners can or cannot claim in terms of asset tax depreciation.

"This intention was signalled by the IRD in late March, when it announced that the treatment of commercial property fit-outs and services may well follow the treatment of its residential counterparts in the future.

"A lot of what is currently claimed by commercial property investors could be denied by IRD in the future. The IRD had listed 16 examples of fit-out applications for residential property, of which only three or four may now be claimed as depreciable assets and are not classified as part of the building."

In another Budget move, the right to claim a 20 per cent loading on the tax depreciation of a brand new asset was removed immediately. However, assets currently attracting this loading will be allowed to continue.

The activities of Loss Attributing Qualifying Companies (LAQCs) - the corporate vehicle used by many residential property investors - will also be treated differently from next year. The 2010 Budget signalled proposed legislation to tax all LACQs as limited partnerships. Laws will be tightened to prevent investors choosing to have losses deducted at their marginal personal tax rate, but profits taxed at the lower company tax rate.

"The Government feels this will ensure both profits and losses incurred are calculated at the same marginal tax rate as that of the investor," says Freeman. "Investors should review these changes in conjunction with taxation specialists to determine the effect upon them and their investments vehicles."

The Budget estimates that these actions on property investment will raise $685 million in 2011/12 rising to $690 million in 2013/14. They are also likely to push rents up, says Freeman.

"Treasury, according to Finance Minister Bill English, is predicting already that levels of rent - both in the commercial and residential arenas - will probably rise as a result of these moves over the next few years."