IRD Cracks down on Chattels

Question

I have been involved in two rental residential properties. These were sold to me as part of our retirement plan. I did not put down any deposit as the borrowings are against our family home. I have been to several seminars and think I understand much of what is said but I have been reading with some concern that the depreciation, which I claim each year, I’m not doing in the correct way. I have been given a schedule of things to claim but I think I cannot do this anymore.  Can you advise please.

Answer

This is an area of investment that is widely misunderstood and any actions need careful consideration and advice. The consequences of getting this wrong can be significant - I must say to begin, that I do not generally like the maximum depreciation model promoted by many – I see nothing but tears - but that is my opinion.

The IRD has been active in recently advising what assets property owners and investors can and can’t depreciate and the news isn’t particularly good. Folk that promote these schemes to investors had taken the view that the individual components in a property as well as the actual building itself could be depreciated.

The Institute of Chartered Accountants had asked for clarification of Inland Revenue's approach to the issue. A statement has been made by ICANZ and IRD, which is précised below.
 
‘Inland Revenue have advised that the asset is the entire building and it is not acceptable for taxpayers to break up residential properties into smaller components in order to obtain higher depreciation rates’. The better view of the law is to apply depreciation to the combined asset (the building) and not accept the practice of ‘breaking up’ rental properties into smaller components to obtain the higher depreciation rates under the ‘building fit-out’ asset category.
 
Those using the component approach will be required to add the value of the ‘components’ they have been depreciating individually into the cost of the building and also combine the depreciation claimed for those individual assets. This will identify the asset to be depreciated, the cost of that asset and the depreciation claimed to date. They should then use the building depreciation rate to claim for that asset.

Folk will be required to take this approach from the first available income year but will not be required to adjust previous income years. Should the asset be sold or change in use - any depreciation that had been over-claimed as a result of using the incorrect depreciation rates will be corrected.

Those who disagree with the Commissioner's view may of course continue to do so. However, taxpayers using the component approach have the opportunity to switch to the Commissioner's approach for future income years with no reassessment for prior years and no imposition of shortfall penalty.

The major problem for many will be that the rental income from properties they have purchased just will not stand up to the level of debt service carried without these maximised depreciation models being used. Be warned – cashflow is king!

Original Article published November 2006