NZ Herald 30 July 2005

APerhaps because you don’t want to run the risk of battling Inland Revenue.

I know how you’re feeling. You don’t want to do the wrong thing, but sometimes you feel like a naïve fool for not doing what everyone else seems to be doing.

More on that in a minute. First, let’s understand what’s going on and why.

You’re not quite correct in saying that wiring, plumbing and so on are sometimes treated as chattels. But in some circumstances they can be categorised as “building fit-out” assets, says an IRD spokesman.

Let’s say, for example, that you are running a business in a building you don’t own — typically a commercial building — and you put in extra wiring, partitions and so on. You can depreciate those items as fit-out assets.

But if you own the building — whether you’re running a business or renting out a residential property — the IRD requires you to depreciate everything that is “permanently affixed to or wrought into” the building at the same rate as the building itself, at 4 per cent a year.

“If you own a car and depreciate it, you don’t depreciate the brake pads separately from the car,” says the spokesman.

How does IRD define “permanently affixed etc”? Well, carpet is not permanent, but lino is. “If you can’t get it out without destroying something, it’s part of the bigger asset.”

It’s similar to the division insurance companies make. A claim for damaged carpet usually comes under a contents policy; a claim for damaged lino under a house policy.

The spokesman acknowledges, however, that some landlords are trying to claim the sort of deductions you write about.

“This trend is based on an argument that a residential property consists of a number of assets that may or may not depreciate at the same rate as the exterior walls and roof,” he says. The argument is strengthened by the very fact that the IRD has a list of depreciation rates for building fit-outs.

“There are some differences of view out there. Some advisers have argued about what’s said in our depreciation booklet. They believe we have somehow given a green light to this practice,” he says.

“But we don’t believe we have changed our view on this. If we audit someone and find they have claimed depreciation incorrectly, we take steps to correct the position, if necessary using the disputes process.”

Because of all the disagreement, IRD’s adjudication and rulings unit plans to issue new guidelines for IRD staff and taxpayers, probably within the next few months.

You also bring up a separate issue: how the proceeds after you sell a rental property are divided amongst land, building and chattels. That, of course, affects how much of your claimed depreciation is clawed back.

The IRD would expect you to use a similar division to the one used when you bought the property, says the spokesman.

If a taxpayer seemed to be minimising any clawback, “the Commissioner would look very carefully at the situation, including any valuation the taxpayer seeks to rely upon, and, if necessary, would apply the anti-avoidance rules where a deliberate attempt was made to distort values.”

A report from a registered valuer doesn’t necessarily cover you. “We’ve had ongoing dialogue with a number of valuers,” he says.

How likely is a landlord to be challenged about all this? Not surprisingly, the spokesman doesn’t give any figures. “Anecdotally there are a lot of cases out there identified by investigators in the field. We’re looking at it more often than we used to.”

He adds, “If any of your readers are unsure of the correct depreciation treatment for their investment properties they should talk to Inland Revenue. We would be pleased to assist them.”

It’s up to you, then. Be richer and more worried, or not quite so rich and a better sleeper.

By the way:

• Not all chattels are depreciated at 18 per cent. The rate for residential rental chattels varies from 12 per cent for fitted furniture to 50 per cent for items such as bedding, cutlery and vacuum cleaners.
• You cannot claim depreciation for a drive. “It would be considered part of the land, and land is not a depreciable asset,” says the spokesman. You can depreciate letterboxes at 7.5 per cent and fences at 9.5 per cent.

AYes, you may be impertinent! The vast majority of my investments are in shares, via well diversified share funds.

I’m not a trader. I’ve read too much research that shows that most traders do worse than those who buy and hold — partly because of transaction costs, which can include tax. Besides, I don’t want to put the time into it.

So you’re right, I don’t have first-hand knowledge of this. I decided, therefore, to talk to a man who knows not just about his own investments but those of his firm’s many clients.

Deloitte tax partner Greg Haddon was quoted in the Herald recently warning people who plan to buy in the upcoming Vector share float in the hope of selling soon after at a profit.

It’s quite likely, he says, that the IRD will check people who quickly drop off the Vector share register. “The department might say, ‘Why did you sell if you didn’t buy for resale?’

“You would have to come up with a plausible reason, for example your son had an accident and you had to come up with some money unexpectedly,” or your gain would be taxable.

The case of the correspondent two weeks ago is not so clear-cut, however.

Let me say, firstly, that I didn’t write that everyone who has sold shares after two years should declare the profits. What I said was:

“If you are regularly selling shares you’ve owned for only a few years — and especially if you’re selling to capitalise profits — you’d be hard pressed to convince the IRD that you didn’t buy “with the dominant purpose of resale”, which means your gains are taxable.”

However, I might be guilty of leaping to conclusions from what the man said. If he genuinely buys shares for the dividends, but his broker occasionally talks him into selling, he doesn’t need to declare the gains. My answer “was a bit black and white,” says Haddon.

The same, though, could be said for some of your statements. Haddon disagrees that the IRD sets a two-year cutoff. He’s aware of people who have paid tax on profits after selling shares held for more than two years, “if it’s pretty clear they bought with the intention of sale.”

“Each situation is unique. There isn’t anything set in stone. You also may get different interpretations from different officers in the department.”

What about court cases? There haven’t been many about trading shares, says Haddon. “The department isn’t very active in this area because it finds it too hard.”

Still, not every case has ended in favour of the taxpayer — although some at first seemed that way.

“The interesting thing is that, in the early 90s, there were a lot of share losses, and a number of individuals took cases to say they were dealers so they could claim the losses.” Since then, they have presumably had to declare their gains, “unless they could show a change in their operations. But it would be hard to argue.”

Nor is Haddon convinced by your charter idea. If your charter merely records that you are taking profits, but leaving that money “in the pot”, those gains could still be taxable, he says.