Repairs vs Assets

Posted on Friday, April 4 2014

Repairs vs Assets

The costs of any repairs carried out on a property are deductible unless is it ‘of a capital nature’. Costs of a capital nature generally refer to improvements and are not deductible. Instead, improvement costs are added to the cost of the asset they improved or are depreciated as a separate chattel.

Take the common scenario of an investor replacing the bathroom in a rental property that they’ve owned for a few years at a cost of $6,000. If that cost is treated as repairs, the tax relief might be $2,000. If that cost is treated as improvements to the building, the tax relief will be $0. That’s a big difference so you want to make sure your accountant understands the rules and isn’t too conservative.

I’ve seen too many cases when accountants see the cost of something like this and instantly treat it as improvements when the cost actually has very little to do with whether a cost is repairs or improvements.

The Tax Law

The only guidance provided by the Income Tax Act 2007 is under section DA 2(1) where is says that a deduction is denied for an amount “to which it is of a capital nature”. As this is not helpful, it is necessary to refer to IRD policy and a large amount of case law precedent to gain further guidance.

The IRD published their policy in 1994 and have not updated it since despite important case law arising since then.

3 Step Process

Repairs maintain a rental property to the condition it was in when that property was purchased. An improvement to a rental property is any alteration, extension or work on a building that increases its capital value or useful life.

These are the steps that we go through when determining whether an amount is repairs or improvements:

(1) Identify the Asset – Is the work being done on the building or is a separate chattel?

a. Building – go to step 2
b. Chattel – if the amount relates to work on part of the chattel, then it will be repairs, if the chattel is replaced then this amount will be depreciated as a separate chattel

(2) Was the work done immediately after the property was purchased?

a. Yes – you could not argue that you are reinstating the property to the condition it was in when it was purchased so any amount more than a few thousand dollars is likely to be improvements
b. No – go to step 3

(3) Is there any structural change or will the work increase the capital value or useful life of the building?

a. Yes – this amount will be improvements and will be depreciated at the building rate of 0%
b. No – this amount will be treated as repairs

Despite all of the above, any amount spent that is $500 or less is deductible.

IRD Examples

Here are some examples that I have extracted from the IRD.

IRD Examples of Repairs

1. Replacing a broken shower head (rental guide)
2. Plastering and painting a crack in the wall (rental guide)
3. Replacing a blown element in a hot water cylinder (rental guide)
4. Redecorating the property to return it to the state it was in when you bought it to use as a rental property (rental guide)
5. House repainted, guttering replaced and front door replaced (example 3 TIB Feb 1994)
6. Replacement reconditioned engine to replace old seized courier van engine (example 6 TIB Feb 1994)
7. Concrete tile roof replaced with new steel-backed tile roof (example 7 TIB Feb 1994)

IRD Examples of Capital

1. Substantial improvements to a rundown property just purchased (rental guide)
2. Adding a conservatory in place of a deteriorated wall (rental guide)
3. Replacing 20 dilapidated horse boxes despite it being more cost effective than repairing the existing horse boxes (example 1 & 5 TIB Feb 1994)
4. Replacing the kitchen, bathroom and merging two adjoining bedrooms into one (example 2 TIB Feb 1994)
5. Paying less for a dilapidated property and then painting, wallpapering and replacing bath and showers before renting it out (example 4 TIB Feb 1994)

Too many times I’m seen accountants say that replacing a bathroom is an improvement. While I would agree if it was done immediately after the purchase of a property, replacing a bathroom down the track would see no structural improvement and no long term increase in value. This is backed up example 7 under the IRD’s examples of repairs. Example 4 under the IRD’s examples of capital is different as that example also contains structural changes.

Don’t be afraid to ask your accountant how they have treated various costs on your property and to justify those decisions. Otherwise, you could be missing out.

Tony Thorne
www.thorneaccounting.co.nz

 

 

 

 

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2 Responses to “Repairs vs Assets”

  1. saleemn says:

    Hi
    I need to consult you about remedial project cost for a leaky home. I bought this house more 10 years back. At that time it was not a leaky building complex. Subsequently the Body Corporate bought a lengthy legal case and got some compensation from the supplier and council. That money was not enough to complete the project and I have to pay about 55K to top up. can I treat this as maintenance and write off or needs to be capitalised.

    To give your opinion how much it will cost.

    Thanks
    Saleem

  2. admin says:

    Halo Saleemmn,
    i think you are asking the wrong person about the possible cost of fixing your home.
    you better talk to qualified builder NOT an accountant.

Expert's Bio

Tony Thorne

Thorne Accounting has been providing specialised accounting and tax services to residential and commercial property investors since 2004. Our mission is to provide the highest quality tax and accounting services to property investors. We are constantly fine tuning the way we work with property investors so we can provide this superior service at competitive prices.

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