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What Chattels Can Be Depreciated Separately In A Rental Property?

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Contributor:
Mary Holm
Mary Holm

Question:

I wonder if you are aware that Inland Revenue will accept property valuations showing a chattels value as high as one third of the value of an investment property purchase, with the consequent depreciation of these "chattels" at the chattels depreciation rate of 18 per cent.

"Chattels" include such things as electrical wiring, plumbing, partition walls (i.e. any wall not holding up the roof), drive, letterbox, fencing and so on, in addition to the traditional chattels such as carpets, curtains and light fittings.

The depreciation of these "chattels" has a significant effect on the investor's tax, and for several years after purchase can result in a refund from Inland Revenue.

The astute investor then appropriately attributes the sale price to the land, building and chattels in the sale and purchase agreement, escaping with no or minimal tax on recovered depreciation.

As a taxpayer I am astounded that IRD should have allowed this situation to arise. But as an owner of two investment properties I am asking myself why shouldn't I take advantage of this apparent laxity?

Answer:

Perhaps because you don't want to run the risk of battling Inland Revenue.

I know how you're feeling. You don't want to do the wrong thing, but sometimes you feel like a naïve fool for not doing what everyone else seems to be doing.

More on that in a minute. First, let's understand what's going on and why.

You're not quite correct in saying that wiring, plumbing and so on are sometimes treated as chattels. But in some circumstances they can be categorised as "building fit-out" assets, says an IRD spokesman.

Let's say, for example, that you are running a business in a building you don't own - typically a commercial building - and you put in extra wiring, partitions and so on. You can depreciate those items as fit-out assets.

But if you own the building - whether you're running a business or renting out a residential property - the IRD requires you to depreciate everything that is "permanently affixed to or wrought into" the building at the same rate as the building itself, at 4 per cent a year.

"If you own a car and depreciate it, you don't depreciate the brake pads separately from the car," says the spokesman.

How does IRD define "permanently affixed etc"? Well, carpet is not permanent, but lino is. "If you can't get it out without destroying something, it's part of the bigger asset."

It's similar to the division insurance companies make. A claim for damaged carpet usually comes under a contents policy; a claim for damaged lino under a house policy.

The spokesman acknowledges, however, that some landlords are trying to claim the sort of deductions you write about.

"This trend is based on an argument that a residential property consists of a number of assets that may or may not depreciate at the same rate as the exterior walls and roof," he says. The argument is strengthened by the very fact that the IRD has a list of depreciation rates for building fit-outs.

"There are some differences of view out there. Some advisers have argued about what's said in our depreciation booklet. They believe we have somehow given a green light to this practice," he says.

"But we don't believe we have changed our view on this. If we audit someone and find they have claimed depreciation incorrectly, we take steps to correct the position, if necessary using the disputes process."

Because of all the disagreement, IRD's adjudication and rulings unit plans to issue new guidelines for IRD staff and taxpayers, probably within the next few months.

You also bring up a separate issue: how the proceeds after you sell a rental property are divided amongst land, building and chattels. That, of course, affects how much of your claimed depreciation is clawed back.

The IRD would expect you to use a similar division to the one used when you bought the property, says the spokesman.

If a taxpayer seemed to be minimising any clawback, "the Commissioner would look very carefully at the situation, including any valuation the taxpayer seeks to rely upon, and, if necessary, would apply the anti-avoidance rules where a deliberate attempt was made to distort values."

A report from a registered valuer doesn't necessarily cover you. "We've had ongoing dialogue with a number of valuers," he says.

How likely is a landlord to be challenged about all this? Not surprisingly, the spokesman doesn't give any figures. "Anecdotally there are a lot of cases out there identified by investigators in the field. We're looking at it more often than we used to."

He adds, "If any of your readers are unsure of the correct depreciation treatment for their investment properties they should talk to Inland Revenue. We would be pleased to assist them."

It's up to you, then. Be richer and more worried, or not quite so rich and a better sleeper.

By the way:

* Not all chattels are depreciated at 18 per cent. The rate for residential rental chattels varies from 12 per cent for fitted furniture to 50 per cent for items such as bedding, cutlery and vacuum cleaners.

* You cannot claim depreciation for a drive. "It would be considered part of the land, and land is not a depreciable asset," says the spokesman. You can depreciate letterboxes at 7.5 per cent and fences at 9.5 per cent.

 

Mary Holm is the author of bestselling books on KiwiSaver and personal finance. She is also a highly praised seminar presenter. Her written advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following that advice. 

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