Lately, much of the taxation focus has been on changes affecting residential property. However, post-election changes are likely coming for commercial property now, too.

In setting their respective tax policies for the recent election, both major political parties stated they would remove the depreciation tax claim from buildings, likely from the 2025 tax year. The saving from which would assist in funding other tax policy changes.

This change to remove commercial building depreciation is not new. Commercial buildings were treated as depreciable property for many years, until it was removed with effect from the 2011 tax year. This occurred as part of wide array of tax policy changes in response to the impact of the GFC.

Part of the stated rationale for removing commercial building depreciation is that property generally increases in value, so it doesn’t really depreciate. Owners of commercial properties will likely dispute, stating that buildings do, in fact, depreciate and require regular expenditure to maintain, and instead, the land is what likely appreciates.

It was, therefore, a welcome relief for commercial property owners that as part of COVID response measures, the then Labour government reintroduced the ability to depreciate most commercial buildings (there were restrictions for some accommodation properties) from the year 2021. This was, in part, an admission that buildings actually don’t depreciate.

Unfortunately for commercial property investors, this change will be short-lived.

What does this mean for commercial property owners?

The headline issue is that they will no longer be able to depreciate their buildings, which will reduce the tax deduction they can claim. As noted, this can be significant as it amounts to a tax deduction of between 1.5% to 2% of the building’s cost/value (depending on the method used).

However, this change does bring into focus the categorisation of what exactly is considered to be a building or part of a building.

While that may sound straightforward, in the world of depreciation, a building is made up of several factors, including “fit-out”. Fit-out continues to be depreciable and at a higher rate than what a standard building rate can.

However, in this regard, it is common for property owners not to be as diligent in separating out the various fit-out components of a building, particularly if they get a depreciation claim for the entire building. However, once that is removed, what could be classified as fit-out becomes increasingly relevant.

Distinguishing between the building and the fit-out can be complicated, but generally speaking, a building in the commercial context will typically include the structure and the weatherproofing aspects. A fit-out could include wiring, internal walls/doors and even some exterior cladding, depending on whether it is decorative. Therefore, having an itemised understanding of what each component of a building is and whether it could classify as fit-out can be very valuable, especially in the absence of building depreciation.

The issue for current owners is if they haven’t already split out their fit-out components, it’s not so simple to start once building depreciation is removed, as they will have already made an election in terms of their depreciation position. Although there can be options that are worth considering in a situation like this so affected owner should consult their advisors to assess what options they have.

For those who have not yet taken a position, for instance, if you are undertaking the erection of a commercial building, it is strongly recommended a thorough review is undertaken to determine what could be “fit-out” and what each component of fit-out costs. The benefit of this could be significant.

At this stage, legislation hasn’t been drafted to remove commercial depreciation, and as always, once introduced, the devil will be in the details. Whether transitional provisions will be introduced, as was the case previously with “notional fit-out", will be particularly interesting, but any evidence of such is yet to be seen. Despite more clarity to come, commercial property investors will need to consider the impact this will have on their rental return and cash flow. They should also seriously look further into their fit-out position and assess whether it is adequate.

To find out more and go deeper into the implications on commercial property matters following the New Zealand election, check out our webinar here.

To speak with a Tax Advisor directly about your specific circumstances, contact us.

The views and opinions expressed in this article are those of the author/s and do not necessarily reflect the thought or position of Findex.

November 2023