Repairs & Maintenance – The Focus of Closer Review
It is no secret that New Zealanders have a long-standing love affair for investing in property, so it is not surprising that property investors are under closer scrutiny from Inland Revenue in regards to their property tax affairs.
One area in particular that seems to be attracting increased focus from the Commissioner, is the deductibility of Repairs and Maintenance. More and more often we are experiencing Inland Revenue requesting further information to support the amounts claimed by property investors in their tax returns.
The legislation that is in place currently, which governs the criteria for deductibility is complicated at best. The Inland Revenue released an Interpretation Statement IS 12/03 to give tax payers guidance and there have been a lot of articles and publications published by professionals in this area as well.
In determining an amount of expenditure, some of the points that the Commissioner takes into account are:
The extent of the work done.
Impact of the work done on overall value and rental yield.
Total cost of the work.
If any betterment has been achieved, keeping in mind that they view having to make improvements for earthquake strengthening and council building consent requirements, to be capital in nature.
At the end of the day, it is the Commissioners view that each case is to be decided on its own merit so the legislation is subject to individual interpretation.
It is not surprising then that often the IRD interpretation differs from that of the tax payer, especially if the amount in question is material.
Now in most circumstances, it can be fairly simple to determine if an amount spent is repairs and maintenance, or on capital account. For example, the replacing of broken shower heads, or mending a fence, these are obvious repairs. It’s not as simple if the work is more substantial due to the lack of a regular maintenance plan, or unexpected circumstances such as a leaky building. Or you have taken the opportunity to do other work on the property, which is more capital in nature, at the same time you have undertaken the repair.
So, what do you do if you are a property investor who finds themselves in a situation where you have incurred significant costs that you believe should be classified as repairs and maintenance. The obvious first step is to talk to your advisor, to get their advice on the correct interpretation before you file your tax return. However, this does not guarantee that the Commissioner would take the same view.
There are three approaches that you can take.
To claim the entire amount of the work as repairs and maintenance. However, if the amount of the expenditure is significant, it is likely that the Commissioner could review this and you would need to be prepared to defend your position that the amount incurred meets the criteria to be deductible as repairs and maintenance. If the Commissioner disagrees with your position and is successful in her argument, and depending on the amount in question, your risk exposure to shortfall penalties and use of money interest can be significant.
Another approach is to capitalise all repairs and then file a Notice of Proposed Adjustment (NOPA) once the assessment of your tax return has been received, to request that the amount capitalised be expensed as repairs and maintenance. In the NOPA we present your argument for the costs or an apportionment of the costs to be repairs and maintenance. If IRD agree with your interpretation, then, they will amend the assessment to include the costs as repairs, allowing the deduction. If the Commissioner does not agree with your interpretation then you are not subject to any penalties or use of interest as you have taken an acceptable tax position from the Commissioners view when filing the initial tax return.
The third approach you can take is to apportion the amount of the work between repairs and capital. Although this is a more conservative approach than claiming the entire amount of the work undertaken, there still have been cases where the Commissioner has successfully argued that repairs done at the same time as capital work, take on the nature of being capital in nature, so still not without risk of review.