A short walk in any direction from the centre of town shows that Tauranga is undergoing something of a construction boom. As these projects near completion it seems an appropriate time to think about how these significant new assets should be recorded in the books.
In 2010 there was a change to the tax law which removed the ability to claim depreciation on buildings (previously depreciated at 3% DV or 2% CP). Further, if a commercial building is sold at a loss (below cost price) there is no deduction available for the loss on disposal. However the ability to claim depreciation on commercial fit out still remains so it is well worthwhile investing a bit of time and energy in doing the exercise of separating out any depreciable components of the build.
In many cases, the building fit-out may be quite tenant specific and by separately identifying the fit out costs it becomes possible not only to claim depreciation for the duration of the tenancy but also to claim a deduction if the fit-out has to be scrapped on termination of the lease. Building fit-out does not have an indefinite life and tends to be replaced periodically either due to obsolescence or in response to tenant changes.
The building itself includes all of the structural items including foundations, frame, external walls, floors, cladding, windows, stairways, roof, external doors and any loadbearing structures. These form the fabric of the building itself and cannot be depreciated.
Commercial fit out includes all of the non-structural items including internal (non-load-bearing) walls and partitions, electrical cabling, bathroom and kitchen fittings, carpets and floor coverings, security systems etc. All of these items can be separated out of the cost of the building and depreciated at IRD approved rates. These rates vary depending on the expected life of the item from 10% for ceilings and heating systems to 67% for electric heaters and hand dryers so there are some potentially worthwhile deductions to be had.
To claim depreciation you will need to establish appropriate values for the building and the separate depreciable fit-out items. For a new commercial build the builder may be able to give a breakdown of the main items. For the purchase of an existing commercial building it is likely that the Sale & Purchase Agreement will not give specific figures. In this situation it may be worthwhile obtaining a valuation from a registered valuer to support the allocation of the cost between the building and the fit-out. Don’t be tempted just to ‘wing it’ – you will need to be able to show evidence that the figures you adopt have a factual basis.
Similarly, if you are doing a refit of commercial premises be alert for any existing items of fit-out that should be scrapped and make sure that you identify any new depreciable items to maximise your depreciation claims.
One thing to bear in mind is that if you have claimed depreciation on fit-out during the period while the building is held there may be depreciation recovered on sale at the point the building is disposed of. There may also be deductible costs on any scrapped items. If you have claimed depreciation on fit-out you may wish to set specific values for these items in the Sale & Purchase Agreement. In this situation we recommend you take advice from your tax adviser before proceeding with any planned sale.
Commercial Buildings with a residential component
It is important to establish that the building is a commercial building as opposed to a residential building (as the rules applying to residential buildings are different). In most cases this will be fairly obvious but there can be some grey areas. A commercial building is defined as a building where the main or predominant use is for non-residential premises. Any residential premises within the building must be of a secondary or minor nature. Where there is a combination of residential and commercial use of a building (as is increasingly common now with the boom in apartment building) an assessment must be made based on floor area for each activity with an apportionment of any shared areas (lobbies, hallways, entranceways etc). Provided the main purpose of the building is commercial it will be possible to depreciate any shared fit-out eg lifts and lobbies. Any fit-out that solely relates to the residential areas will not be depreciable.
Hotels, motels, serviced apartments, rest homes etc can generally still treated as commercial buildings because they are not ‘residential’ establishments but commercial accommodation providers.
If you are buying an existing commercial building be alert for any fixed plant items that could be depreciable. Even though these may be integrated into the fabric of the building there is a provision that allows for these items to be depreciated. This could be specialised equipment eg wool scouring plant, gantry crane or lifting equipment. Provided you can establish a separate value for these items they can also be depreciated. These large items are best listed in the Sale & Purchase Agreement so that their value is established clearly at the outset but, again, if this is not done you may wish to obtain a written valuation.
There are some real opportunities for tax savings over the period of ownership if you can establish separate values for commercial building fit-out from the start.
BDO have recently completed a nationwide construction survey with over 200 respondents from construction companies, subcontractors, material suppliers and consultants. The report is available for download here.
Janine Hellyer is a Director with BDO Tauranga Limited.
Disclaimer: This article is general in nature and should not be treated as professional advice. It is recommended that you consult your advisor. No liability is assumed by BDO Tauranga Ltd for any losses suffered by any person relying directly or indirectly upon the article above.