12 May 2020
The Inland Revenue Department (IRD) recently issued a draft statement regarding the tax deductibility of costs incurred by owners of residential rental properties, to meet Healthy Homes Standards.
Since July last year, owners of residential rental properties must ensure their properties meet certain insulation and smoke alarm standards. Further standards will be added from July 2021 to include heating, ventilation and other matters. Their application will initially be on a progressive basis as tenancies change after that date, with full compliance required by July 2024.
At Findex, we are frequently asked by clients whether expenses they incur as a result of this new regulation are tax deductible. This is generally assessed on a case by case basis, taking into account the specifics of each circumstance.
When determining whether Healthy Homes costs are of a revenue nature or non-deductible capital expenditure, we firstly identify what the relevant asset is and then assess the costs against that background. For example, the relevant asset may be the building itself or it may be the item upon which cost has been incurred, such as a heat pump or panel heater.
Once the asset has been identified, the general tax position is the expenditure will be a non-deductible capital expense if it results in the reconstruction, replacement or renewal of the whole asset or substantially the whole asset. The expenditure will similarly be non-deductible if it goes beyond general “wear and tear” and changes the character of the asset.
The IRD’s draft statement runs to 13 pages, and the published statement relating to repairs and maintenance generally is 55 pages long, highlighting that an assessment can often be complicated.
The draft statement notes expenditure on minor additions or alterations to the property may be revenue in nature. For example, if a small amount of insulation is installed over a built-in wardrobe to ensure a residential rental property meets the insulation standard.
It notes the use of modern materials alone does not necessarily mean the work is of a capital nature. The statement recognises the work required to meet the Healthy Homes Standards may mean replacing one item with another that is made of more modern or superior materials. An example is given of deductible expenditure on replacement insulation that is superior to the original.
Finally, to further illustrate the judgment required in this area, the draft statement notes expenditure that may otherwise be deductible can take on a capital nature in circumstances where it forms part of a larger project.
If you would like to know more about the tax rules relating to residential property and the Healthy Homes regulation, or in relation to real estate more generally, please contact one of the team here.
This information is general in nature and readers should seek specialist advice before making financial decisions.