COUNT ON IT: Careful planning needed on rentals

THE effect of the Budget moves on property investment can be minimised by careful planning at the time the rental is purchased.
The choice to invest in property is often taken because of the prospect of a tax-free capital gain, and the ability to offset losses is not the primary motivating factor.
The Budget introduced measures that will reduce the amount of losses available to taxpayers, but the absence of a capital gains tax may mean that New Zealanders will continue to invest in property.
The measures introduced were the removal of the ability to claim depreciation on buildings that have a life of 50 years or more and a limitation on the amount of losses that can be accessed from a Loss Attributing Qualifying Company (LAQC).
These new rules will apply from the 2011/12 income year. It will be very important to get a valuation completed that separately identifies the various components of the building.
The IRD has issued an interpretation statement that sets out the commissioners' view on determining whether an item in a residential rental is separate of depreciable property or whether it is part of the building.
If an item forms part of the building, it will now no longer qualify for any depreciation.
To determine whether a particular item is part of or separate from the building, apply a three-step test.
 Whether the item is in some way attached or connected to the building. If the item is completely unattached, then it will not form part of the building.
 Whether the item is an integral part of the residential property where it would be considered incomplete and unable to function without the item. If the item is an integral part, then the item will be a part of the building.
 Whether the item is built in or attached or connected to the building in such a way that it is part of the fabric of the building.
Consider factors such as the nature and degree of attachment, the difficulty involved in the item's removal and whether there would be any significant damage to the item and building if it was removed. If the item is part of the fabric of the building, then it is part of the building.
The inability to claim depreciation on buildings makes it even more important to correctly identify whether expenditure is a repair and fully deductible for tax purposes, or is capital in nature and gets added to the cost of the building.
The Budget also provided IRD with more resources to investigate and this may be an area that will receive more attention.
The proposed restrictions on the amount of losses that can be accessed from an LAQC will mean taxpayers will need to reconsider what type of entity they use for ownership.
Currently with an LAQC, all the losses are attributed to the shareholders in proportion to their shareholding and are immediately available to offset against the shareholders' income from other sources.
 It is proposed that losses will still be distributed to shareholders but will be restricted to the shareholders' equity, with the balance of the losses retained in the company.
If the rental investment creates losses, then an ordinary partnership may be a better vehicle for ownership. This will allow access to full losses at the time they are generated, plus the ability to access capital gains without the need to wind up the partnership.
It is important that cashflows are prepared to determine whether losses or profits will be generated and advice taken on the appropriate structure for your individual circumstances.
Existing rental property owners who currently rely on the losses generated may look to sell prior to March 31, 2011.
* Disclaimer: No liability is assumed by Staples Rodway Tauranga for any losses suffered by any person relying upon the article above. It is recommended you consult your adviser before acting upon this information.
Shirley Seales is from Chartered Accountants, Staples Rodway Tauranga.