Never let tax get in the way of a sound business decision
Depreciation Deductibility on Residential Property Investments
July 2010
One of the most important rules any tax advisor should learn, is never let tax outcomes get in the way of a business decision. Firstly, the deal has to stack up on its own. Tax benefits and costs are secondary.
Recent changes to the way property will be taxed have led to much discussion as to the fairness for the property investor. Some are considering selling their properties as they expect the tax burden will be increased so much to make holding onto the property uneconomic.
This specifically relates to depreciation deductibility for tax purposes on residential property.
In fact in most cases depreciation is just a tax deferral, as most properties will sell for more than what they cost, causing depreciation recovered, taxable in the year of sale. What is claimed as a deduction over the years of ownership is given back on sale.
The only benefit of depreciation over the year is a savings in tax; allowing slightly increased debt repayments or cash in the bank. The benefit is the time value of these funds, the tax saved yet to be returned to IRD as tax on depreciation recovered.
The biggest prize from property ownership is clearly increase in value, the main business consideration that drives most investors to make their investment decisions.
A review of Real Estate Institute New Zealand figures for average residential sales values of properties over the past 10 years has shown an increase in Auckland of 87% and the rest of New Zealand an increase of 110%.
Over the same period, the time value of money saved from depreciation deductions amounted to only 1.8% for Auckland and 1.6% for the rest of New Zealand, of these increases in property values.
The Auckland increase was $211,443 and the time value of money $3,877. The rest of New Zealand was $166,541 and $2,651 respectively.This clearly reinforces the old adage that tax should not influence a business decision.
It is proven the return from investing in property for a period of time significantly outweighs any tax consequences that will follow from property investors being denied a depreciation deduction, if New Zealand experiences similar increase in property prices in the future.
For those who are selling their property because the tax consequences have driven them to it, are likely to be making that decision for all the wrong reasons.
Important: Items contained in this newsletter are general comments only and do not constitute advice. Changes in legislation may occur quickly and clients are recommended to seek our formal advice before acting in any of the areas.
Robert Willis
Director
CST Nexia Ltd
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