Does depreciation need to be paid back to IRD?

Question from Mavis updated on 2nd October 2012:

I have a rental property which has been tenanted for three and half years. I have claimed depreciation of $15,000 on the building and chattels under a LAQC. I have a couple of questions. Firstly, does the depreciation need to be paid back to IRD (also, for the building or for both the building and chattels)? Secondly, is the recovery dependent on when the settlement date is? Does it apply only to rental properties making a profit? What if my rental is still making a loss? If I settle, then the accumulated depreciated will be added as income and will offset loss incurred during the year. So I might get a smaller refund or even pay some tax. Is it going to make a difference which year I settle in?

Our expert Mark Withers responded:

The Government’s decision to disallow further depreciation deductions on buildings does not, in itself, trigger an obligation to recover accumulated depreciation. The obligation to recover what has been claimed though remains and is typically triggered by sale of the property or deemed disposal, in situations like the owner removing it from the rental pool or moving back into it themselves. Depreciation must be recovered on all depreciated assets (the building and the chattels) to the extent that the disposal proceeds exceed their depreciated book values. Once your disposal proceeds exceed the cost of the asset all depreciation claimed is subject to recovery. The issue with chattels is simply that their actual value on disposal may well reflect the book value of less but you will need to be able to prove this if you are to avoid the recovery. The tax timing of a sale is typically determined by its settlement date, this was a principal established in the Gasparin case, so the timing of settlement will determine which tax year you must bring the recovery to account in. If your recovery is triggered by a deemed disposal, it is brought to account on the first day of the next income year. Whilst depreciation recovery typically feels like a tax hit at the end, the positive spin on it is that you have claimed deductions throughout the life of the asset that have probably reduced your tax bill at a time when the tax rates were a lot higher than they are now. Watch out also for issues associated with managing provisional tax obligations if the recovery leaves you with a tax bill of over $2,500 you are in provisional tax teritory and may wish to contemplate filing an estimate for the following year if the recovery income is not likely to re occur.

Mark Withers and his team at Withers Tsang & Co specialise in advising on property related transactions, valuation and restructure services and tax planning.

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