Article: Law & Finance
Repairs and Maintenance Or Capital Expenditure? with Fraser Hurrell
The stakes will be higher in the distinction between repairs and maintenance and capital expenditure on residential rental properties from April 2011. Repairs and maintenance is typically tax deductible. But from the start of the next tax year, no tax deduction will be possible for depreciating capital expenditure on most buildings.
The line separating these two types of expenditure can be fine – and the costs of getting it wrong can be high no matter which way you err. If repairs and maintenance costs are wrongly treated as capital expenditure, these costs will fall into a black hole with no chance of a tax deduction. And if during a routine risk assessment the IRD finds capital expenses wrongly claimed as repairs and maintenance, further attention will follow. That attention will likely result in repayment of any tax wrongly claimed, penalties, use of money interest - and the possibility of a full audit.
On one end of the continuum, expenditure that restores the building to the condition when you purchased it is likely to be tax deductible repairs and maintenance. At the other extreme, work that improves the building is likely to be capital in nature. And from the next tax year, these capital costs will typically be unable to be depreciated.
Black and white on the face of it, right?
But between these extremes, this can get rather grey. Property investors often solve pressing maintenance issues during capital expenditure. Or they may use improved materials for an enhanced result during routine repairs and maintenance.
How do you treat the cost of replacing the somewhat tired original roof on your 1960’s era rental property that has sprung a serious leak in a storm?
Is this capital expenditure or is it repairs and maintenance to your rental property: Fitting a modern new kitchen as an alternative to sinking money into repairing the old chipboard kitchen cabinets that have become soft and musty after years of leaking taps and hard use by tenants?
What if you take the opportunity to replace rotting timber joinery with modern aluminium windows after complaints from your tenants about the draughts? How do you stand with replacing a stained old toilet bowl and a cistern that no longer flushes reliably with a crisp new water saving unit? Or replacing the bathroom floor that is showing signs of rot around the shower and basin with a new, waterproof tiled floor?
There is often no black and white answer. The correct treatment often comes down to the particular facts and circumstances. And every situation will have its subtle differences that may affect the reasonableness of one position versus the other.
Check with your Chartered Accountant before assuming that your expenditure will or will not pass scrutiny as tax deductible repairs and maintenance. A little bit of careful professional attention will go a long way towards maximizing your tax deductions without falling foul of the IRD.
Fraser Hurrell is a director of Elevate CA. He has a particular interest in property investment matters, structuring and financing options for business – and managing due diligence and the business sale and purchase process. Fraser is also the Elevate CA business valuation specialist. He regularly presents at business seminars.
