Rental property depreciation clawback

BY MARY HOLM

Q. In your August 24 article regarding clawback on depreciation on rental property, mention was made of apportioning the sale price between land and buildings.

Is there also a need to place a value on the chattels sold?

A. Usually when buying a new house or apartment for rental purposes, and it is fully furnished, the subsequent depreciation is made up largely of what is calculated on fixtures and fittings, particularly in the first year.

I assume that the IRD does not include in its clawback the depreciation claimed on the rental property contents.

Also, I wondered if the clawback on the property occurred if the owner decided to live in it and then sold it a few years later.

I suppose the IRD might want its pound of flesh for the years in which it was rented out, if they learned about it.

Yes, you do need to value the chattels when you sell. And I'm afraid your assumption is wrong. If they are worth more than their depreciated value, that difference will be clawed back.

The good news is that, if some of the chattels are worth less than their depreciated value, you can deduct that difference.


(Note that this doesn't apply to buildings. If you sell a building for less than its depreciated value, that's too bad.)

In practice, you usually end up with what KPMG national tax director Craig Macalister calls overs and unders for chattels. You balance the deductions and clawbacks, and might end up with a net clawback or net deduction.

Each chattel has its own economic life, says Macalister. Some items may be depreciated over five years; others over 10.

A landlord who has owned a property for many years may have several chattels depreciated close to zero but, in fact, they still have value.

And clawbacks can sometimes be substantial, especially when high-value items such as a swimming pool are included.

Sometimes, Macalister adds, people have pages and pages of depreciation. When they sell, it's an enormous amount of work.

The valuations at the time of selling might be made by a professional valuer, perhaps the same one who valued them when you bought the property, or by an auctioneer. You have to make a reasonable attempt. The IRD will generally accept that, says Macalister.

In answer to your second question, the day of reckoning is usually on sale.

However, if the property goes through a change of use - for example, the landlord moves into it himself or herself - this is a deemed disposal.

If the property's market value on the first day of the next income year - for most taxpayers, the following April 1 - is higher than its depreciated value, that difference is added to your taxable income that year.

That's fair enough. Over the years you've been deducting an expense that hasn't involved a cash outlay.

Still, it can be tough coming up with what might be many thousands of dollars when you haven't got any sale proceeds to take the money from.

Because of these sorts of situations, a rule was introduced in 1997 that allowed taxpayers to elect not to depreciate property and chattels that would otherwise be depreciable, says Macalister.

This is particularly useful for people who rent their property during a short absence overseas, he adds.

But, if you've already gone down the depreciation track, you can't get off it now.

* Mary Holm is a freelance journalist and author of Investing Made Simple

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