Taxwise: Death, tax and depreciation

By DENHAM MARTIN

It is often said that only two things are certain in life: death and taxes. Since the abolition of death duties, one would think that the two would not necessarily coincide.

However, a situation where they may has come to light with moves by some Inland Revenue regional offices over the recovery of depreciation on the death of a taxpayer who owned depreciable assets. This shows the negative impact of a sudden move to follow the strict letter of the law, and is a sign to those preparing returns to date of death that depreciation must be considered.

One of the principles of the depreciation rules is that on the transfer of an asset for which depreciation has been claimed, the transferor must account to Inland Revenue for any amount "recovered" in the sale price above the tax book value of the asset. This "depreciation recovery" depends on whether a "disposal" of the asset has occurred for depreciation purposes.

Several common transactions come within the definition of disposal; for example, sales, distributions from trusts, taking property outside New Zealand and theft.

The question arises whether the death of a taxpayer and the transmission of assets to an executor of his/her estate is considered to be a disposal for depreciation purposes.

There are two schools of thought. One is that a disposition requires some action on the part of the transferor, rather than a passive transmission, with the result that no disposal can occur on death. The executor steps into the shoes of the deceased, and continues to claim depreciation deductions as if it were still the deceased's asset. This is the view adopted by most accountants.

The other school of thought is that a transmission involves an alienation of property that must constitute a disposal. This is the view the IRD offices are taking, and is a marked policy change. The outcome has far-reaching consequences for those who prepare returns for the deceased and estates, and for advisers to beneficiaries under wills. Should the death of a taxpayer be considered a disposal, the return to date of death would need to include depreciation recovered of the difference between the market value and the book value of the asset. Under tax legislation, the disposal of the asset would be deemed to occur at market value. Inland Revenue has recently claimed that a mismatch may occur between this side of the transaction and the ability of the recipient, the executor of the estate, to claim depreciation where nothing has been paid for the asset.

In general, where someone acquires a depreciable asset for no cost, no depreciation deduction is available to that person over the life of the asset.

If Inland Revenue is correct, the mismatch may be echoed later when the beneficiary takes title to the property from the executor. Again, where depreciable property is acquired for no cost, the recipient may not be able to claim depreciation deductions.

These comments are also relevant to trust resettlements. Family trusts owning depreciable assets that have claimed depreciation as a cost may choose to resettle those assets on to further trusts. A resettlement is likely to be regarded as a disposal for depreciation purposes if it is being made on to an entirely new trust.

Given that the recipient trust acquires the assets for no cost, it is possible that in certain circumstances no depreciation deduction could be claimed by that trust over the life of those assets. If this interpretation is correct, this disadvantage must be weighed against any benefits that a resettlement of assets may bring.

* Denham Martin is the principal of Denham Martin & Associates, specialists in advice on taxation and related matters.