Depreciation is a word that strikes both joy and dismay into the hearts of investment property buyers and sellers.
The concept of depreciation is straightforward. It's the value an item loses each year as it slowly wears out and needs to be replaced.
Back in the day (prior to April 2011) investors could claim depreciation of both the building and the chattels against income on the property.
That allowed many to make a paper loss. Both building and chattel depreciation could be entered on a tax return as expenditure.
This was deceptive, says specialist property accountant Michael McCook of AccountabilityNet.
When the owners went to sell, the depreciation claims over the years could be clawed back by the Inland Revenue Department (IRD) if the building hadn't actually depreciated — which of course most residential, and commercial properties don't in reality thanks to the maintenance being done on them and capital growth.
In 2011 the IRD reduced the depreciation rate on buildings that have an estimated useful life of 50 years or more to zero.
If you claimed building depreciation on a residential property prior to April 2011, the depreciation claimed may need to be paid back to the IRD when you sell, says McCook.
Investment property owners can still claim depreciation for chattels, which can tip the equation in favour of buying a property that would otherwise make too much of a loss to be economic.
Using "negative gearing" means the losses from property investments can be claimed against tax on the investor's day job. It's a common strategy among property investors in New Zealand.
"Chattels" include everything from carpet to stoves, fridges, furniture, curtains, light fittings, dishwashers, waste disposers, TV aerials, range hoods, burglar alarms, heated towel rails, heat pumps and more. Each item will have its own depreciation rate that can be claimed each year.
Investors do need to be careful to understand the fine line between chattels and fixtures.
Claiming on the latter, which might be a carport, gazebo that is bolted to the floor, an in-ground spa pool and other items fixed to the property can get them in hot water with the IRD.
When making that decision the investor is required by the IRD to identify the extent to which items are "attached" to the building and to determine whether they are integral to the function of the building. If they are attached and integral there is no opportunity to depreciate them.
Commercial investors can also depreciate fit-out, which includes items such as air conditioning units, handrails, fences, electrical cabling, fire protection equipment, sewerage, water reticulation and many more, says McCook.
Once identified as chattels or fit-out, the purchase cost of these items can be claimed in full as expenses in the year they are bought providing they cost less than $500.
Otherwise they need to be capitalised and depreciated over time.
The depreciation rates range between 8 per cent and 60 per cent depending on the item in question.
It really can be worth using an expert such as a registered valuer and accountant who are knowledgeable about the depreciation rules.
Many residential and commercial property investors get a chattels or fit-out valuation done when they buy in order to claim on the second-hand items that came with the property.
A valuation maximises depreciation and reduces the risk of IRD penalties. The calculations need to be documented and kept in case of an audit.
There are tricks and traps when it comes to depreciation. For example it's not uncommon for business owners to own live/work commercial properties where they live above a warehouse or other operation.
For that they need to quarantine the section of the building that is their principal place of residence. They can only claim chattels depreciation on the part of the building that is used for their business or rented out.
Holiday accommodation owners who rent rooms in their homes can also depreciate chattels and claim this against their taxes.
But it must be according to the IRD's schedule and only chattels in parts of the house used by guests as well as the claim being proportionate to the total number of guest nights during the year.
In the case of a TV in a shared lounge, for example, only a percentage of the cost could be deducted according to the space for guests in comparison to the entire house and then reduced by the percentage of nights in the year guests stay.
Inherited properties come with stings in the tail for accidental landlords. If you inherit a rented property, the IRD treats the property as if it was sold to you at market value and may claw back depreciation that was claimed prior to April 2011.