If you’re a commercial or residential property investor the stakes are about to get higher in the distinction between repairs and maintenance and capital expenditure. Repairs and maintenance costs are typically tax deductible. But from the start of the next tax year, no tax deduction will be possible for depreciating most capital expenditure on most buildings.
The line separating these two types of expenditure can be fine – and the costs of getting it wrong can be high no matter which way you err. If building repairs and maintenance costs are wrongly treated as capital expenditure, these costs may fall into a black hole with no chance of a tax deduction. And if during a routine risk assessment the IRD finds capital expenses wrongly claimed as repairs and maintenance, penalties, use of money interest and a full audit may follow.
On one end of the continuum, expenditure that restores the building to the condition when you purchased it is likely to be tax deductible repairs and maintenance. At the other extreme, work that improves the building is likely to be capital in nature. And from the next tax year, these capital costs will typically be unable to be depreciated.
Black and white on the face of it, right?
But between these extremes, this can get rather grey. Property investors often solve maintenance problems during capital expenditure. Or they may use improved materials for an enhanced result during routine repairs and maintenance.
How do you treat the cost of replacing the somewhat tired original roof on your 1960’s era building that has sprung a serious leak in a storm?
Is fitting a new kitchen capital expenditure or repairs and maintenance? How about when the old chipboard cabinets have become so soft and musty that the kitchen is generally unhygienic after years of leaking taps and hard use by tenants?
What if you take the opportunity to replace rattling timber joinery with modern aluminium windows after complaints from your tenants about the draughts?
How do you stand with replacing a stained old toilet bowl and a cistern that no longer flushes reliably with a crisp new water saving unit?
Or replacing a timber floor that is showing signs of rot around a wet area with a new, waterproof tiled floor?
There is often no black and white answer. The correct treatment often comes down to the particular facts and circumstances surrounding the expenditure. Every situation will have its subtle differences that may affect the reasonableness of one position versus the other.
Check with us before assuming your building expenditure will or will not pass scrutiny as tax deductible repairs and maintenance. A little bit of careful attention will go a long way towards clarifying the situation and maximizing your tax deductions without falling foul of the IRD.