96 — April/May 2015 — Build 147

Departments/Business matters

By Mike Rudd, Tax Director, Staples Rodway, Auckland

IT HAS BEEN 3 YEARS since the ability to claim tax depreciation on buildings was removed. When this change was made, Inland Revenue carried out a review of the depreciation rules around the fit-out of commercial and industrial buildings.

Can still claim depreciation on fit-outs

The review was to bring greater clarity to the distinction between a building and building fit-out given their different tax treatment.

In particular, no tax depreciation deduction is available for a building. Even if the building is sold at a price below original cost, no tax deduction is permitted for a loss on disposal.

The situation is quite different for building fit-outs. Tax depreciation deductions are available, and a tax gain or loss can arise when the fit-out is disposed of, with or without the building.

The tax effect can vary significantly depending on the approach taken by the

taxpayer both when building fit-out is acquired and when it is disposed of.

Applies to commercial building fit-outs

For tax purposes, building fit-out is referred to using the term ‘commercial fit-out’. The rules ensure that the fit-out of commercial buildings are depreciable property.

Almost all fit-out of residential premises is non-depreciable, unless relatively minor fixtures and fittings such as garage door motors and curtains are accounted for separately.This includes plantThe definition of commercial fit-out states that items of plant attached to a commercial building are generally commercial fit-out and are able to be depreciated separately from the building.

The intention is for all plant to be depre-ciable unless the item is used in residential premises.But not structural itemsThe second limb of the definition of commercial fit-out is intended to exclude

Fit-out costs a taxing issue

Tax depreciation deductions on building fit-outs are available, but eligibility depends on several factors.

Build 147 — April/May 2015 — 97

structural items from being commercial fit-out.

For a building with an estimated life of 50 years or more, commercial fit-out will not include structural items. These are founda-tions, building frame, floors, external walls, cladding, windows, external doors, internal stairways or the roof and loadbearing struc-tures such as pillars and loadbearing internal walls.

They should be included as part of the cost of the building and not depreciated.

Check it is a commercial building

The definition of a commercial building is important as it is tied to the definition of commercial fit-out.Work out the main useA commercial building is one where the main use is for non-residential purposes and any residential premises within the building are minor or secondary. In most instances, it will be obvious whether the main use of a building is to provide non-residential premises.

However, if it is not clear what the main use of a building is, taxpayers will need to take a position based on their particular circumstances.

A method for determining the building’s main use could be on an area basis. Take care to allocate the shared areas appropriately – for example, lobbies and entrancewaysthat commercial and residential tenants can normally access.Include shared fit-out itemsIf the dominant or main purpose of a building is commercial, items of shared fit-out will be depreciable as commercial fit-out. An example is where commercial tenants occupy most of the floor area but the top floor has a residential apartment.

The shared items of fit-out, such as elec-trical cabling, fire protection equipment, sewerage and water reticulation, and the fit-out of lobbies that are not part of the resi-dential premises are depreciable. However, the fit-out within the apartment would gener-ally not be depreciable property.

Some commercial buildings have residentsThe rules recognise that there are commer-cial buildings that provide residential-type accommodation. Specific residential-type buildings can still be treated as commer-cial buildings, and therefore depre-ciation claimed on any commercial fit-out, including:

● hotels, motels or similar ● certain serviced apartments ● rest homes or retirement villages, except places that are places of residence for independent living.

Split the building and fit-out values

Items of commercial fit-out will usually be disposed of at the same time as the building it is in. Typically, the sale price on land and buildings does not specify how much is being paid for the building and how much for the fit-out.

The split between the price paid for a building and for the different items of fit-out in the building can be crucial from a tax perspective.

Potentially the disposal of a building could involve no tax effect, unless depreciation was claimed in earlier periods.

However, the disposal of commercial fit-out that has been depreciated can result in a real effect on taxable income, whether from depreciation recovered or a deduct-ible loss on disposal. Losses on disposal of commercial fit-out are tax deductible.

If the amounts involved are large enough, obtaining a property cost-allocation study can be a worthwhile investment to identify the market value of fit-out disposed of on an asset-by-asset basis. In many cases, this does give rise to a tax-deductible loss on disposal.

It’s equally important when acquiring a building and commercial fit-out together for a single price. Obtaining support for splitting the asset acquired between the building and commercial fit-out can provide depreciation deductions while the building is held. Note This is intended as general advice only.

Contact your advisor or Staples Rodway if you

have any specific questions about this topic.