Money matters: The taxing subject of when to depreciate

By MARY HOLM

Q. The Government no doubt had a very good reason to change the depreciation legislation (giving people the choice of whether to claim it, once again, see last week's Money Matters) - that is to get more revenue from us.

If I choose not to depreciate and pay the full tax on the rental income now, then the Government gets more out of me than if I sell in the future, and they claw back the depreciation then. Inflation will erode the value of the clawback.

Ten years ago I bought a house for $80,000. It is now worth $160,000. Following that trend, in 20 years, when I retire, it will be worth $640,000. ( I maintain it will.)

If I then decide to sell it, and the depreciation is clawed back - say $70,000 - then the tax on that $70,000 will be minimal in 2020.

Likewise, my parents bought land 40 years ago for 2000 ($4000). If it had been a rental property and they sold it now, the tax would not be very much, even at 33 per cent, today.


A. Your argument is a good one. It's partly, but only partly, weakened by the fact that inflation is much lower now than it used to be.

Let's start from the top. I think you might be a bit unfair on the poor old Government. After all, they've given us a choice of using the old way or a new way.

I suspect what prompted the change was that many people hadn't realised, when they sold their rental property at a gain, that they would have to pay tax on depreciation claimed over the years. It all came as a bit of a shock.

Accountants tell me this happens more often than we might expect.

But for those people who do understand the clawback situation, you're absolutely right. Assuming tax rates don't rise, it is better to get a tax break now and have to repay that money later.

And that's not just because inflation erodes the value of the money. Even if inflation was zero, a dollar today is still worth more than a dollar later. (There, I've said it again.)

These days, though, we need to take note of our assumption about tax rates not rising. Some people will have claimed depreciation at 33 per cent but will pay the clawback at 39 per cent. Not such a good deal.

If tax rates rise further, they'll be hurt more. If they fall, they'll be helped.

Turning to your own experience, the tax on $70,000 probably will seem low in 2020. But that's partly because that's all the depreciation you could claim in the first place.

If property values grow fast, the value of depreciation claims falls fast.

Also, you might be being a bit optimistic about your house price rises. So far, your investment has doubled in 10 years, which means your annual return is just over 7 per cent. But I wouldn't be too confident that, in a low-inflation environment, it will continue to grow that fast.

House prices can't get too far out of whack with inflation and incomes. Otherwise, no one could afford a house

While we're at it, another reader asked, "If you held a property until it was fully depreciated, do you then have to have it revalued?"

Firstly, it's unlikely to happen. Generally it takes 30 to 40 years to depreciate a property down to zero. Once you've done that, that would be the end of any depreciation for you.

For a property passed down within a family, the IRD notes in its booklet IR 264, "If the property has been inherited, the cost price for depreciation is nil, because there was no cost to the current owner." This means the person who inherits couldn't claim any depreciation.

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