Repairs and Maintenance – When a Deduction
Sometimes it’s the small questions that crop up over and over.
When National announced the nationwide subsidy initiative for insulation of homes it sparked a steady stream of calls from clients wanting to know whether the cost of insulating their property investment was tax deductible or not. And now we have the labour leader’s bill before parliament trying to up the ante again by creating minimum standards for rented property, including insulation.
Unfortunately, on this occasion the politicians seem to have missed the low hanging fruit.
It’s fair to say most landlords will prick up their ears at the suggestion of a tax deductions on offer. If the government simply asked the IRD to confirm the tax treatment of retrofitted insulation and confirmed its deductibility I’m sure many landlords would willingly make the spend, subsidy or not.
So why is the deductibility question difficult?
The question of whether a cost is deductible maintenance or a non-deductible capital improvement is often a grey area. The tax departments typical response is to simply say “we consider every case on its merits” which doesn’t assist much!
There is however a form of analysis that does assist. It goes like this...
Step 1. Identify the asset.
Step 2. Consider the nature and extent of work to be done.
Step 3. Consider the project as a whole.
Step 4. Does the work go beyond remedying fair wear and tear?
So, using a retrofit insulation project as an example, where does this lead us on the deductibility question?
Firstly, in the context of insulation the expenditure does not create an asset in its own right. The insulation forms no useful purpose unless it is installed in a building. The building is therefore the asset not the insulation itself. So far so good.
Secondly, consider the nature and extent of the work. Here things get a bit more tricky, are we just going to put insulation in the ceiling or are we going under the floor as well? If we do the walls we have a greater cost and task because the gib needs to be penetrated and repaired and a paint job done at the end. So probably doing the minimum would still leave us confident but if we do a full number we are probably a bit more marginal.
Thirdly, consider the whole project. By this I mean, are we just doing an insulation project or is this just a single component or a much larger project to renovate the building. Our chances are greater of arguing for a deduction if we are simply doing the insulation project. The more that’s happening at the time, the more likely IRD would argue the entire project was capital in nature.
Fourthly, does it go beyond fair wear and tear? This is the interesting one. Is an uninsulated home in this day and age “fit for purpose”? If the asset is the building and the building is not fit for purpose if uninsulated is dealing with the installation just redial work?
Then the really curly one, was there insulation there before? If there was insulation there before and we are replacing old with new using a modern alternative we are almost certainly going to be OK on an R & M claim. If however there was no insulation previously we are still exposed to the prospect of having improved the property rather than repaired it.
So we land back where we started with some uncertainty, perhaps then not surprising that the IRD’s stock response is “we consider each case on its merits”.
At the coal face, some other factors can influence the call based on, how long has the property been owned and rented? Did the rent increase after the work was done, did the insured value of the house alter after the work. These are all questions IRD can and do ask when auditing a claim like this.
So, if the government really does want to see more rental homes insulated, before they spend time and money debating the new bill, why not just offer some clarity on the deductibility question. If they confirmed the deductibility, the uptake would be immediate.