Buying an older, neglected property to renovate and rent out has been a common pathway toward financial prosperity for many kiwis. Those skilled in the trades are especially well placed to build wealth in this way, given they are able to save money by doing a lot of the renovation work themselves.
It is wise to consider the tax side of things before embarking on this type of project. A recently issued Technical Decision (TDS 24/02) from Inland Revenue highlighted one lesser-known tax implication of this type of “renovate to rent” project.
The issue was decided by the Tax Counsel Office (TCO) and involved the degree to which the costs of renovation could be deducted for income tax purposes.
In this case, the taxpayer bought a block of flats that was quite neglected. After buying the flats, they replaced the kitchen units, added dishwashers and heat pumps, replaced the bathroom fittings, carpets and vinyl, repaired and repainted the walls, and cleaned and repaired the roofs.
The taxpayer then claimed the expenses as a tax deduction on the basis that the work was done to bring the property back to its original condition.
Inland Revenue’s Customer and Compliance Services (CCS) disagreed with this, saying the work done went beyond ordinary repairs and maintenance, and the amount spent on this work was part of the cost of acquisition of the property. In other words, they argued the taxpayer received a discounted purchase price because the properties were not in good order at the time they were bought.
In the end, the TCO decided in favour of Inland Revenue, stating that the expenditure was part of the cost of acquiring the property, and was therefore a capital cost which cannot be deducted.
This case highlights the sometimes murky boundary between what is a capital (non-deductible) expense and what is a revenue (deductible) expense. It is safe to conclude that if you are taking on a “renovate to rent” project, where you are receiving a discount because significant repairs are needed, there is a strong chance these repair costs cannot be fully deducted for income tax.
Given the ability to deduct expenses can make a critical difference to the viability of such projects, giving thought to this issue and talking through your plans with your accountant at the outset may well help avoid surprises down the track.