Depreciation and investment property values

WITH MARY HOLM

Q. I was interested to read your comment that any depreciation claimed on a rental property that rises in value will be clawed back by the IRD.

I agree that most properties will sell for more than you paid for them over a period of time.

However, it is usually the value of the land that increases, not the value of the house (unless you do improvements to it).

It is only the value of the house that you are claiming depreciation on, so how do IRD assess what the value of that dwelling is at the time of sale?

Are you able to advise if there is a time period after which you are not required to repay tax deductions on depreciation when you sell?

Also, how is the amount calculated, given that the rebates could have been claimed over many previous years using varying tax scales.

A. Do I detect a hint of anxiety? I'm not sure I can give you much comfort. Still, better the devil you know.

When you sell a rental property, you need to apportion the sale price between the land and the building.

Inland Revenue says you can use the valuation numbers used to set your rates. Or you can get a valuation from an independent valuer.

Despite what you say, the value of the house does usually rise over time - albeit perhaps not as fast as the land value - even if you don't make improvements.

Why? New house prices (excluding land) rise as inflation pushes up building materials costs. And old and new houses are in the same market. Many buyers look at both.

Given that the value of any house is what someone is willing to pay for it, the prices of old houses tend to rise with new ones.

In some cases, if an older house has antique qualities such as high-quality timber, Victorian wooden lace or art deco design features, its value will rise even faster than new houses. Sometimes, though, the value of a house may fall. And experts note that the values of commercial buildings - and to a lesser extent units in apartment buildings - are more likely to drop than houses.

If you're investing in one of those, it may be wise to get building valuations when you buy and when you sell.

On to your next question, about whether there's a time limit on depreciation clawback.

Those selling real estate sometimes claim there is. But there is not.

There are two possible sources of the myth. One relates to a complex law that was repealed in 1990.

The other is that you have to keep tax records for seven years.

That doesn't mean, though, that the clawback doesn't reach back longer than that. It goes all the way back to when you bought the property.

The clawback calculation is quite simple if you sell the house for more than you paid for it.

All the depreciation you've claimed over the years is added to your taxable income in the year of sale.

If you sell for less than you paid, but still more than book value (purchase price minus depreciation taken over the years), it's a bit more complicated.

In that case, some of the depreciation (the difference between the sale price and book value) will be added to your taxable income.

As you suggest, maybe the IRD should take into account your varying tax rates over the years.

But that could be a bureaucratic nightmare. Also, it assumes the house appreciated at a steady rate, which almost certainly won't be true.

What's more, it could just as easily work against you as for you.

In any case, I reckon landlords do pretty well out of the deal.

Firstly, you've had the use of the money over all those years. You're lucky you don't get charged interest on it. It is, after all, like a loan to you from other taxpayers.

And if you happen to be on a lower tax rate at clawback time than when you took the deductions - a common situation for retired people - you don't even pay back all the "principal".


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