COMMENT: Tax deductibility of rental property upgrades

Given the ongoing publicity and often heated discussions, all landlords should know that there are a number of mandatory upgrades that will be required for all residential rental properties over the next few years.

It is already compulsory to install smoke alarms in all such properties and we are very near the time the first part of the insulation installation requirements will be enforced.

On the 1st July, unless your property can be shown to fall into one of the exemption options, your rental will require ceiling and underfloor insulation to either the 1978 standard or the 2008 standard.

Then, over the next few years, we will be looking at the so-called Healthy Homes requirements. These include insulation to the 2008 standard, the supply of heating appliances, underfloor moisture barriers and compulsory extractor fans.

While a considerable number of properties will now not come onto the rental market in the first place, others will be placed into the ‘too hard’ basket, the tenants told to leave, and the property sold.

Most of the remaining rental properties will require work that will cost actual cash money – substantial money in many cases. The work will not be “free”, despite some such claims.

There has been much uninformed drivel written about the actual costs. Some say: “So extractor fans are dirt cheap, all you need for the moisture barrier is a couple of rolls of polyurethane, and how much are heaters these days?”

This completely ignore two vital components of the work – the often costly implications of retro fitting electrical appliances into an existing, possibly dated, power system and the labour component of the work involved.

I’m currently getting the outside of a standard 1960s weatherboard house professionally painted, and I can assure you that the cost of doing that is many, many thousands of dollars more than the price of a few tins of paint.

We now enter into the murky waters of the tax deductibility for such work.

The rules around the deductibility of residential rental property expenses are, in theory, quite simple. The condition of the property on the day you acquired it established the benchmark.

Any subsequent expenditure incurred in getting the property back to that condition is a legitimate tax-deductible expense. But any spending on improving the property beyond the condition it was on that day is classed as capital improvements and therefore non-deductible.

This seems simple. But, in many cases confusion reigns.

If a component of the property deteriorates and needs replacing but you decide to upgrade your replacement the tax-man can become quite unfriendly. Last week I heard of a landlord who needed to replace the existing windows in an investment property. In itself, quite deductible.

However, he was attracted by the idea of moving to double glazing rather than replacing like with like. This would cost $5000 more. Could he claim the quoted costs of the like-for-like replacement as a deductible expense, and treat the extra $5000 as capital expenditure?

No, he was told. If he double glazed, the entire cost would be capital and there would be no tax deduction at all. Zilch. I’m sure that this ruling would have greatly influenced his final decision.

So to keep a rental property running as an income-earning business you, as the owner, will be required by the new legislation to carry out and pay for these upgrades.

I have seen many queries like this: “Surely if I am compelled to spend this money in order to continue my rental business, I should be able to treat that unavoidable and mandatory cost as a deductible expense?”

The bad news is that it does not work that way. The IRD’s interpretation of the tax law remains that if you improve the insulation, pay for the extractor fans and the heating, then regardless of the reason that is improvement and, sorry, no deductibility.

In law they are quite correct in saying that. The NZ Property Investors Federation has made representation to the Government that there should be some tax allowance for the cost of this work but received a very fast and firm rebuff.

That means that while you may be able to claim depreciation on some of these items over time, the full cash impact will be right now.

Given that one of the publicly stated aims of all this legislation is to reduce costs to the public purse within both the health system and the education system through “fewer hospital admissions and fewer school days lost” it would seem to be fair to do this.

However, the current refusal to provide some tax allowances means that effectively private landlords are directly funding the costs of implementing these public sector savings.

Actually, we are paying twice, as the price of every item of insulation, every roll of polythene and every hour of paid labour to install these upgrades incurs GST, which then also goes directly into the Government coffers.

A case of we lose, and the Government wins twice.

Read more:

Revealed: Healthy Homes minimum standards

Cost of standards will hit tenants