Polson Higgs
Depreciation Changes Means More Analysis Required by Building Owners
By Frank Burgess
Building owners can no longer claim depreciation on buildings as a result of last year’s tax changes.
In the past, due to the depreciation deductions available for buildings, owners would often simply capitalise the full cost to the building asset and depreciate accordingly, without looking into it further.
No depreciation on buildings means greater focus should be placed on analysing building costs to ensure that owners are obtaining the full deductions to which they are entitled.
There are several common situations which building owners may face.
Firstly, when buying a building, investors should consider getting a chattel valuation, and then look into classifying chattel items separately to the building itself. In general, any item that is non-structural may be able to be classified separately to the building and, therefore, continue to be depreciated.
Secondly, when constructing a new building, owners should clearly analyse contractors’ costs to ensure the appropriate split between chattels and the building proper. This may include an apportionment of overall project costs, such as consultants’ fees.
For existing building owners, concessionary relief may be found in the “fit-out pool” which can be calculated. This relief applies to owners who have not split out their chattels, or “fit-out” as it is referred to in tax terminology, from the cost of the building itself when they first bought the property.
These owners may establish a “fit-out pool” based on 15% of the building’s adjusted tax value. However, any fit-out which has been recognised separately since acquisition of the building must be deducted from this calculation, leaving many owners with little or no relief.
A common (and the trickiest) situation is where building owners carry out refurbishments or repairs to their properties.
When a building is refurbished, the costs can be classified as one of the following:
- Repairs and maintenance (fully deductible), or
- Building fit-out (can be depreciated), or
- Building (no depreciation)
This is a complex area of the law, with no clear legislative or policy guidelines available. There is some case law, which gives conflicting guidance and means that it is easy to jump to the wrong conclusions.
The standard approach to determine whether something is a repair is to:
- Identify what the costs relate to
i.e. what is the “asset” that is being repaired or refurbished. - Determine the nature of the costs that have been incurred
i.e. the total amount of expenditure; is it recurring or one-off; is it an improvement of the asset or simply bringing the asset back up to the standard it was in at the time the asset was purchased; does it relate to the whole or part of the asset. - The work is then measured against the asset in order to work out whether it is a deductible repair or a capital replacement/ improvement
So what does this really mean? For example:
A business spends $1 million redoing the interior of its showroom.
The total expenditure can be viewed as replacement of the previous building fit-out. The “asset” is identified as the building fit-out, so the expenditure is capitalised and depreciated.
However, say we take the view that the “asset” is the building itself, and upgrades to fit-out are simply part of the upkeep of the building asset. The whole amount of the expenditure may then be able to be classified as repairs and maintenance expenditure - and fully deducted.
The difference in results would be:
- A full deduction of $1 million in the year in which the refurbishment is carried out if the building is the “asset” (i.e. a tax benefit of $280,000 at the company tax rate), versus
- a 7% (default depreciation rate for building fit-out on a straight line basis) annual deduction of $70,000 (tax benefit of $19,600 per annum).
Clearly there is potential that the tax treatment could have a major impact on the cash flow for a business.
- Frank Burgess is a taxation specialist with chartered accountants and business advisors Polson Higgs. frank.burgess@ph.co.nz
Disclaimer: This information is intended to highlight recent developments and issues and should not be used as a basis for making decisions. We recommend you seek professional advice from us before taking action on any specific issue.
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Last updated: Friday, 2 December 2011 | 9:09:24 a.m.
