The rules around depreciation of residential properties changed from April 1 2011. Property investors/landlords can no longer claim depreciation on the building structure. They can however still claim depreciation on chattels and fitout.
The changes are a double edged sword. In the past investors may have over depreciated the building component to improve cash flow, only to be faced with a substantial bill at point of selling the property.
Chattels and fitout do tend to have a much shorter life than the building structure. They reduce in value over time through wear and tear. Investors can legitimately claim the depreciation on these items while avoiding depreciation claw back when they eventually sell the property.
Whether the Item Part of the Structure or Chattel/Fitout dictates if it can be depreciated
If the item is part of the structure it cannot be depreciated. If it is a chattel it can be depreciated. To meet the definition of a chattel depends on a three tier test.
We refer you to the appropriate IRD publication. Follow this link for the INTEREPRETATION STATEMENT IS 10/01
In essence to determine whether an item is depreciable the following test applies:
Step 1: Determine whether the item is in some way attached or connected to the building. If the item is completely unattached, then it will not form a part of the building. An item will not be considered attached for these purposes, if its only means of attachment is being plugged or wired into an electrical outlet (such as a freestanding oven), or attached to a water or gas outlet. If the item is attached to the building, go to step 2.
Step 2: Determine whether the item is an integral part of the residential rental property such that a residential rental property would be considered incomplete or unable to function without the item. If the item is an integral part of the residential rental property, then the item will be a part of the building. If the item is not an integral part of the residential rental property, go to step 3.
Step 3: Determine whether the item is built-in, attached or connected to the building in such a way that it is part of the “fabric” of the building. Consider factors such as the nature and degree of attachment, the difficulty involved in the item’s removal, and whether there would be any significant damage to the item or the building if the item were removed. If the item is part of the fabric of the building, then it is part of the building and cannot be depreciated.
The IRD interpretation statement clears up a number of nagging issues. Items previously claimed for such as electrical wiring, plumbing, plumbing fixtures & fittings, internal non load bearing walls, kitchen cabinets, some decks, are now part of the structure and thus not able to be depreciated.
Other items however such as water heaters, air conditioners, fences, some types of decks and a list of standard chattel items can still be depreciated.
Properties Purchased Before April 2011
If you owned the property prior to April 1st 2011, and did not obtain a Depreciation Schedule which separated out assets into the various classes, you will not be able to claim depreciation.
Properties Purchased After April 2011
If you purchased a property after April 2011 it would be wise to obtain a Depreciation Schedule so you can maximise your depreciation claim. This will allow you to maximise cash flow. We advise you to seek guidance from your accountant.
You can now take full advantage of your depreciation entitlement, with minimal risk of claw back on disposal. The issues around depreciation recovery are now negligible and we have clarity from IRD around what can be depreciated separately from the building.
If you don’t apportion you cannot claim depreciation
Disposing of Properties
If the property being disposed has a current Depreciation Schedule (Chattel Valuation) we would advise you obtain an Exit Schedule. This gives a current value for chattel items which will have diminished in value over time. This will help reduce any depreciation claw back.
Properties Still Owned Purchased Prior to April 2011
If you still own the property and have had a Depreciation Schedule completed prior to 2011, you need to comply with the new regime. We advise you to discuss this with your accountant.
Notwithstanding it is your responsibility to ensure that items IRD considers to be part of the building structure are no longer claimed for. To determine if items are considered to be part of the building refer to the earlier three step process and to the IRD interpretation statement. For clarity items no longer able to be claimed for include non load bearing walls; electrical wiring; plumbing; plumbing fixtures; kitchen cabinets (fitted furniture); tiles; vinyl; garage doors; telecommunications cabling; some decks and canopies, depending on the level of fixing to the building.
The apportionment of curtilage is important from a GST perspective. Curtilage is the portion of a rural or commercial property which is used for domestic purposes (i.e. not part of the taxable activity) and as such is GST exempt.
Apportionment apply when there is a residential use combined with an economic activity. Examples are economic rural farms, lifestyle farm lets, orchards, hotels and motels, corner dairies or other combined commercial or industrial use, where the proprietor or manager lives on the premises. It also applies to vacant land where a residential use is planned.
Two dictionary definitions of curtilage are as follows:
Definition 1 – The area, usually enclosed, encompassing the grounds and buildings immediately surrounding a home that is used in the daily activities of domestic life.
A garage, barn, smokehouse, chicken house, and garden are curtilage if their locations are reasonably near to the home.
Definition 2 – Curtilage is a legal term describing the enclosed area of land around a dwelling. It is distinct from the dwelling by virtue of lacking a roof, but distinct from the area outside the enclosure in that it is enclosed within a wall or barrier of some sort.
It is typically treated as being legally coupled with the dwelling it surrounds despite the fact that it might commonly be considered “outdoors”.
This distinction is important under US law for cases dealing with burglary and with self defence under the Castle Doctrine. Under Florida law, burglary encompasses the English common-law definition and adds (among other things) curtilage to the protected area of the dwelling into which intrusion is prohibited. Similarly, a homeowner does not have to retreat within the curtilage under Florida’s Castle Doctrine.
The curtilage (like the home) is also protected from unreasonable search and seizure.
Unfortunately there is no guideline within New Zealand taxation legislation to limit and define curtilage. It does not specify a particular area of land. Rather than looking at the physical characteristics, the Valuer needs to consider the ‘purpose’ to which the land will be put.
On an economic farm unit, it may be an obvious and measurable area which could take into account the gardens, courtyard, access to the dwelling, orchard (providing the latter is not used for income generation), etc. The contemplation is that these areas will be used primarily for personal occupation and not for business purposes.
Lifestyle blocks are more problematic. Many people live on uneconomic 10-15 acre blocks which, for practical purposes, are just large house dwelling lots. They might fatten a few livestock, keep a few free range chickens, grow some fruit and vegetables, etc. But very few of them are economically viable.
Generally the district plan will limit construction to one dwelling per lifestyle block. The minimum size of the block might vary from 5-15 acres depending on geographic location. Given the uneconomic nature of these activities (most are below the GST threshold) there might be a valid argument that the entire lifestyle block should be considered to be curtilage. In effect it is nothing more than a house on a very big section.
However to complicate this, a purchaser might consider that they can make an income from the small block. Therefore it is their right to register for GST, if they so wish. In our view, it is not the Valuer’s responsibility to dissuade them from this course.
There is no SSAP which mandates a process to value curtilage.
One approach which seems to have been given the tacit approval of the majority of Valuer’s is to compare the value of curtilage with prices paid for residential building sites in the nearest town.
For example, say the price of a similar quality site in the nearest township was $180,000, this price becomes the base line and then needs to be adjusted upwards or down for quality, landscaping, etc. Positive adjustments might be made for contributory items such as tennis courts, pools, domestic orchards, glass houses (used for domestic purposes), etc.
Extract from the Tax Information Bulletin Volume Three, No. 5 March 1992
GST – Farm Houses and Section 21(5) Deductions Discussion
When farm land and a residential dwelling are sold in one transaction, we consider that the single transaction can be “apportioned” or “divided” into two separate supplies for GST purposes. The first is the supply of farm land, and the second is the supply of the residential dwelling including land attached to the residential dwelling. This land is often referred to as “curtilage”.
The supply of the farm land and the supply of the residential dwelling must then be considered independently to determine whether GST is charged by the vendor or an input tax credit can be claimed by the purchaser.
The supply of farm land by a registered person will fall within the terms of Section 8 of the GST Act. It will be subject to GST at 15%. The supply of a residential dwelling (including curtilage) is not a supply “in the course or furtherance of a taxable activity” and will not be subject to GST.
Whether a purchaser is permitted an input tax credit on acquisition of the farm land and residential dwelling depends on whether the farm land and/or the residential dwelling are acquired for the principal
purpose of making taxable supplies.
A dry stock farmer (registered for GST) decides to sell bare farm land (farm land without stock). On the
land there is a residential dwelling which the farmer has lived in. The farm land is valued at $135,000 and the dwelling (and curtilage) is valued at $85,000. The farmer wants to know whether GST should be
charged on the transaction.
The supply of the farm land is a taxable supply and GST (15%) must be charged on the value of the farm land ($135,000). The supply of the residential dwelling (and curtilage) is a private sale and no GST is charged.
A hobby farmer (not a registered person for GST) sells bare farm land to a neighbour who is registered
for GST as a farmer. On the farm land there is a residential dwelling. The sale price is $235,000 with the residential dwelling (and curtilage) valued at $100,000 and the farm land valued at $135,000. The
neighbour intends to use the farm land to run stock and will live in the residential dwelling. The purchaser wonders if a secondhand goods input tax credit can be claimed.
Because the supplier is not a registered person no GST is charged on the transaction.The farm land is acquired for the principal purpose of making taxable supplies (the farming business) and a secondhand goods input tax credit can be claimed of $15,000 (1/9 of $135,000). The residential dwelling (and curtilage) is not acquired for the principal purpose of making taxable supplies, so no secondhand input tax credit can be claimed.
A registered person (a dry stock farmer) sells a farm consisting of:
The orchard is sold “lock, stock, and barrel” as a going concern. The vendor finds a purchaser (a registered person for GST) who is interested in buying the property with the intention of using the farm land in an already existing farming business. The purchaser also intends to continue the orcharding business. The parties agree the purchase price will be $450,000 “plus GST (if any)”. The vendor now wants to know whether GST should be charged on the transaction.
The supply of the farm land is a taxable supply and GST (15%) must be charged on the value of that supply ($150,000). The supply of the residential dwelling is not subject to GST as it is not a supply in the course or furtherance of a taxable activity. The supply of the orchard is the supply of a “taxable activity as a going concern” and is subject to GST at 0%.
The vendor charges GST at 15% on the $150,000 ($18,750) and GST at 0% on $200,000 ($0). No GST is charged on the sale of the residential dwelling. The purchaser can claim an input tax credit for the farm land only ($18,750).
Reference: H.O. GST A.5.1F Technical Rulings Ch 110.9