IRD cracks down on chattel depreciation

Many developers and investors have taken the view that they can depreciate individual components in a property as well as the actual building itself.

However the Institute of Chartered Accountants has asked for clarification of Inland Revenue's position, and what the Inland Revenue approach to the issue will be.

ICANZ has produced a statement, in conjunction with the Inland Revenue Department, which provides a clearer view.

“Inland Revenue have advised that its view is 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 Commissioner advises that his approach is:

* The better view of the law is to apply depreciation to the combined asset (i.e. the building) and not to accept the practice of "breaking up" rental properties into smaller components in order to obtain the higher depreciation rates listed under the "Building fit-out (when in the books separately from building cost)" asset category.

* Taxpayers who have been using the component approach will be required to add the value of the various "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 depreciation for that asset.

* Taxpayers will be required to take this approach from the first available income year (the earliest period for which no return has been filed or assessment issued).

* Taxpayers will not be required to adjust previous income years. Should the asset be sold or leave the tax base for some other reason - such as a change in use - any depreciation that had been over-claimed as a result of using the incorrect building fit out depreciation rates will be corrected as a result of the adjustment required by section EE 41 of the Income Tax Act 2004.

* For cases still under investigation, or proceeding through the disputes process, Inland Revenue will consider allowing the taxpayers to take up the Commissioner's approach to settle the matter. A taxpayer may of course decide not to settle and to take the matter through the disputes process if they do not agree with the Commissioner's treatment.

ICANZ says it is pleased a “pragmatic approach” has been taken.

“Taxpayers who disagree with the Commissioner's view may of course continue to do so. However, taxpayers who have been using the component approach now 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 IRD is planning to put out an Interpretation statement on the matter soon.