Chapter 6 - Depreciation
6.1 - Overview (ITA Subpart EE)
Expenditure on capital assets cannot be deducted immediately. The value of the asset depreciates over time and the cost is spread over its useful life. Costs are thereby matched against any income that the asset generates and the tax deduction occurs each year on a more gradual basis until the asset is fully depreciated.
Two methods of depreciation are available:
diminishing value (DV); and
straight line (SL).
The Commissioner prescribes different rates to different assets. Calculators and “Depreciation Rate Finder” are available on the IRD website where you can print out depreciation tables for different assets, asset categories and industries. Go to HERE or click on the link from the tools and calculators section of the FBA website.
Individual assets costing $5,000 or less, excluding GST, may be pooled and depreciated together, at the lowest rate applying to assets in the pool, using the DV method.
6.1 - Overview (ITA Subpart EE)
6.2 - Application (ITA Subpart EE)
6.2.1 - Depreciable Property (ITA s EE 6)
6.2.2 - Depreciation Formula (ITA EE 9 - 36)
6.2.3 - Excluded Depreciable Property (ITA EE 7)
6.2.4 - Entitlement to Depreciate (ITA s EE 1)
6.2.5 - Requirement to Depreciate (ITA s EE 8)
6.2.6 - New vs Used Assets - 20% Loading (IR 265)
6.2.7 - Land Improvements (ITA schd 13)
6.2.8 - Intangible Assets (ITA s EE 62, schd 14)
6.2.9 - Leasehold Improvements and Reservation of Title (ITA ss EE 3, EE 4)
6.2.10 - Disposals and Change of Use (ITA ss CG 1, EE 44-52)
6.2.10.1 - Disposal of Depreciable Property
6.2.10.2 - Change of Use
6.2.10.3 - Cost of Disposal
6.2.11 - Depreciation of Commercial Property
6.2.12 - Residential Rental Property Depreciation (ITA s EE 28)
6.3.1 - Depreciation - A Non Cash Expense
6.3.2 - Maximise Depreciation
6.3.3 - Adjustments for Private Use
6.3.4 - Low Value Asset Right-Offs (ITA s EE 38)
6.3.5 - Automatic Deduction
6.3.6 - Limitations to Deductible Depreciation
6.3.7 - Industry Categories
6.2 - Application (ITA Subpart EE)
6.2.1 - Depreciable Property (ITA s EE 6)
Depreciable property is defined as any property of the taxpayer that might reasonably be expected to decline in value while used or available for use in earning assessable income. All assets, which would be expected to decline in value while being used in normal circumstances, are depreciable property unless specifically excluded.
6.2.2 - Depreciation Formula (ITA EE 9 - 36)
The depreciation calculation formula has four components:
annual depreciation rate
cost of the asset
the date that ownership is acquired
the depreciation method (straight line or a diminishing value)
The annual depreciation rate is the rate at which the asset may be depreciated. These rates are available on the IRD website. Taxpayers generally adopt the diminishing value rate as it gives rise to a greater deduction in early years than the straight line method.
Example
An item of plant is purchased on 1 April in year one. The depreciation rates for the item are 19.2% diminishing value or 12.6% straight line. The plant cost $50,000.
On a diminishing value basis, depreciation in year one and year two is calculated as follows:
depreciation in year one is $50,000 x 19.2% = $9,600
In year two the depreciation is based on the depreciated book value which in year two is $40,400 (i.e. $50,000 - $9,600). Depreciation in year two is $7,757. Thus the residual value of the asset at the end of year 2 would be $32,643. In contrast, under the straight line method the lower rate of 12.6% is applied to the capital cost of plant each year. Therefore, depreciation in year one is $6,300 and depreciation in year two is the same. This would yield a residual value of $37,400.
Depreciation is calculated on a monthly basis and you may start depreciating the asset from the first day of the month in which it was purchased. For example, if an asset is purchased in the last month of the financial year, the depreciation will be limited to one twelfth of the annual depreciation amount.
6.2.3 - Excluded Depreciable Property (ITA EE 7)
A number of items are excluded from the term depreciable property, i.e. no depreciation deduction is available for these items. These include:
trading stock
land (except for specified improvements to land as set out in 6.2.7). See also 6.2.11 and 6.2.12 re: buildings with a useful life of 50 years plus
certain intangible property (See 6.2.8)
property written off per the low cost write-off provisions (See 22.3.2.2)
property that the taxpayer has elected to treat as not depreciable
property that does not decline in value, etc
6.2.4 - Entitlement to Depreciate (ITA s EE 1)
In order to claim a depreciation deduction in respect of the business asset, the asset must be both owned and used or available to use in the business.
6.2.5 - Requirement to Depreciate (ITA s EE 8)
A taxpayer may elect that an asset be treated as “non depreciable”. As a result, no depreciation deductions are claimed over the life of the asset and likewise when the asset is sold, no depreciation is recovered. See your professional advisor for further details.
6.2.6 - New vs Used Assets - 20% Loading (IR 265)
New qualifying assets (assets not previously used in New Zealand) and imported second-hand assets (excluding motor vehicles) acquired after the start of the 1996 income year and before 20 May 2010, are entitled to an additional 20% loading on the depreciation rate.
Assets that qualified for the 20% loading prior to 20 May 2010, will continue to do so, but not later improvements to these assets.
New assets acquired from 20 May 2010, are depreciated using the general rates with no loading.
6.2.7 - Land Improvements (ITA schd 13)
While land itself does not depreciate, certain land improvements are now classed as depreciable property. There are 18 types of depreciable land improvements that include: different types of buildings, bridges, dams, fences, retaining walls, roads, tanks and tunnels. These items, if built or acquired by the taxpayer on or after 1 April 1993, can be depreciated.
6.2.8 - Intangible Assets (ITA s EE 62, schd 14)
Certain classes of intangible property acquired after 1 April 1993 are depreciable. Intangible property that is depreciable includes:
the right to use a copyright
the right to use a design or model, plan, secret formula or process
a patent or the right to use a patent
the right to use land
the right to use plant and machinery
the copyright in software, the right to use a copyright in software, or the right to use software
the right to use a trademark
specified rights under the Radio Communications Act
specified rights under the Resource Management Act
copyright in a specified sound recording
Ensure that you obtain specific advice before making a depreciation claim for intangible assets.
6.2.9 - Leasehold Improvements and Reservation of Title (ITA ss EE 3, EE 4)
The lessee is deemed to own a fixture or improvement to land and is thus entitled to claim depreciation if:
the lessee incurs the expenditure, and
the fixture or improvement under land law is property of the lessee
Purchasers of goods which are subject to a reservation of title clause, prohibiting title to pass until payment has been made, can also claim depreciation deductions provided the purchaser takes possession, there is an unconditional contract and the contract is subject to the Sale of Goods Act.
6.2.10 - Disposals and Change of Use (ITA ss CG 1, EE 44-52)
6.2.10.1 - Disposal of Depreciable Property
When you sell a depreciable asset for an amount in excess of its depreciated tax book value, a taxable depreciation recovery will arise. The amount of this taxable depreciation recovery will not exceed the total depreciation claimed by the taxpayer on the asset. When a depreciable asset is sold for less than its depreciated tax book value, a loss on sale will arise. This loss on sale is deductible. No depreciation expense is allowed in the year of sale. When an asset is sold for more than cost, the difference is a capital gain.
6.2.10.2 - Change of Use
Where the use an asset changes so that depreciation is no longer tax deductible, there is a deemed disposal at market value and this may give rise to taxable depreciation recovery. The reverse applies when a private asset is used for business purposes. That is, the asset is deemed to have been acquired at market value.
6.2.10.3 - Cost of Disposal
Before calculating the amount of any gain or loss on sale, the cost of disposing of that asset should be deducted from any proceeds received. This could reduce the amount of depreciation recovered.
6.2.11 - Depreciation of Commercial Property
Commercial building means a building that is not, in part or in whole, a dwelling, unless use as a dwelling is a secondary and minor use. “Dwelling” specifically excludes:
hotels, motels, inns, hostels, or boarding houses;
certain serviced apartments, where additional services are provided and where the residents do not have quiet enjoyment;
rest homes or retirement villages, except those that are characterised as places of residence for independent living;
hospitals, convalescent homes, nursing homes, or hospices; and
camping grounds.
While depreciation has been scrapped for all buildings with a life of 50 years or more, fit-out of commercial buildings remains depreciable. This section applies to these long-life buildings.
The non-depreciable building core includes foundations, the building frame, floors, external walls, cladding, weather-proofing, windows, external doors, internal stairways, the roof and load-bearing structures associated with the building such as pillars and load-bearing internal walls.
Mixed use: The fit-out of residential premises is generally not depreciable, subject to the rules in 14.3.9. For mixed-use buildings, the dominant purpose prevails. If the dominant purpose of the building is commercial, items that are shared for both purposes will be depreciable as commercial fit-out. However, attached items inside a dwelling are treated as residential, while attached items that are used in relation to (but not inside) a dwelling are included in the commercial fit- out of a commercial building.
Plant that is attached to, but not integrated into the structure of, a commercial building is generally an item of commercial fit-out and therefore can be depreciated separately unless it is used inside a dwelling in the building.
Lifts are depreciable property with an estimated useful life of 25 years, but the lift shaft is part of the building.
Example
1. Three floors of a building are commercial but there is a penthouse apartment.
The shared items of fit-out, such as the lift, electrical cabling, fire protection equipment, sewerage and water reticulation, and the fit-out of lobbies that are not part of the residential premises are depreciable. However, the fit-out within the apartment is generally not depreciable subject to the rules in 14.3.9.
2. A residential apartment block has a café downstairs. The shared fit-out throughout the building will not be depreciable. However, the fit-out of the café will be depreciable as commercial fit-out because it is not used in relation to, and is not part of, a dwelling.
Transitional rule: A transitional rule continues to apply to commercial buildings acquired before the start of the 2012 tax year, where the fit-out is embedded in the tax book value of the building and was not itemised separately.
Owners could create fit-out pool, of 15% of the building’s adjusted tax book value at the end of the 2011 tax year, less any subsequent commercial fit-out acquired and separately depreciated before the 2012 tax year. The pool may be depreciated at 2% per annum until the building is disposed of. When the building is sold, no loss or recovery rules are applied to the fit-out pool.
6.2.12 - Residential Rental Property Depreciation (ITA s EE 28)
Depreciation has been scrapped on all residential and commercial buildings with a life of over 50 years, and the IRD released its ruling on depreciation of chattels, removing taxpayer discretion.
The interpretation statement IS 10/01 sets out a three-step test to determine whether an item can be depreciated separately or whether it is to be treated as part of the building.
Step 1: Is the item in some way attached or connected to the building? An item will not be considered attached for this test, if its only means of attachment is being plugged or wired into an electrical outlet (such as a freestanding oven), or attached to a water or gas outlet. If the item is attached to the building, go to step 2.
Step 2: Is the item an integral part of the residential rental property such that it would be considered incomplete or unable to function without the item? If so, then the item will be a part of the building. If the item is not an integral part of the residential rental property, go to step 3.
Step 3: Is the item part of the “fabric” of the building? Consider the degree of attachment, the difficulty involved in the item’s removal, and whether there would be any significant damage to the item or the building if the item were removed. If the item is part of the fabric of the building, then it is part of the building for depreciation purposes.
The following examples have been included in the appendix of the interpretation statement (IS 10/01: Residential rental properties - Depreciation of items of depreciable property):
The IRD is expected to review aggressive depreciation practices in light of the three-step test. For residential property owners who have split the building out into all its requisite parts, we recommend that you review your tax fixed asset registers for compliance with this approach. Download the IRD guide IR264 on renting out residential property and holiday homes, including depreciation rates from their website.
6.3 - Practical Hints
6.3.1 - Depreciation - A Non Cash Expense
From a tax planning perspective, depreciation deductions are somewhat unique in that they offer an income tax shelter without affecting cash flow in years following the asset purchase. For many years, commercial and residential property investors factored in this tax saving when assessing the overall rate of return on a property. Depreciation at 3% on a property costing $1 million reduces taxable income by $30,000 p.a. Since 2011-2012, depreciation is no longer tax deductible on buildings with a life of 50 years or more.
Depreciation on most other capital assets remains deductible (including property chattels) and the principle still applies.
6.3.2 - Maximise Depreciation
Often significant business assets are made up of a number of different component assets that may be depreciated at higher rates, offering the opportunity for depreciation savings.
Example
If you purchase a printing machine for $100,000, the depreciation rate applicable will range between 12% and 30% depending on the type of machine. It may be possible to split out “sub assets” including for example the “software” which runs the machine. The software may be deductible at 50%.
Before a business can take advantage of this opportunity, there must be a factual basis for identifying the cost of the component assets. Ensure that the cost component is separately analysed on the invoice, or get an independent valuation where the sums justify this outlay to support an allocation of cost to the component parts.
6.3.3 - Adjustments for Private Use
Where an asset is used for business and private purposes the annual depreciation claim should be reduced to make allowance for this private usage. (Note, if you pay fringe benefit tax on private use or enjoyment of an asset, no depreciation adjustment is required).
If you have assets that are subject to private use, let your financial advisor know and they will take this into account when preparing your income tax return. Failure to make these adjustments can result in the imposition of penalties.
6.3.4 - Low Value Asset Right-Offs (ITA s EE 38)
Assets costing $500 or less (excluding GST for GST registered taxpayers and including GST for taxpayers not registered for GST) can be written off immediately, subject to certain conditions. See tax planning comments in 22.3.2.2.
6.3.5 - Automatic Deduction
If depreciation is not deducted in the asset owner’s tax return, the tax book value of the asset is reduced anyway by the amount of depreciation that should have been deducted.
If you do not wish to depreciate an asset (so that there is no significant depreciation recovery if sold), you should elect that the asset is not to be treated as depreciable property (See 6.2.5). Otherwise, you may inadvertently be deemed to have claimed depreciation. Consult your tax advisor for details.
6.3.6 - Limitations to Deductible Depreciation
Various restrictions are placed on the depreciation of assets acquired from associated persons. For assets acquired from associated persons, depreciation can be limited to the amount that would have been available to the associated vendor if the asset were not sold.
This can create significant tax issues where the associated purchaser’s purchase price is greater than the tax book value of the associated vendor. The Commissioner has a discretion to allow the assets to be depreciated at the purchase price if:
The sale is bona fide and at arms length
The purchase price is a fair market value for the assets
An application must be made to the Commissioner to exercise his discretion. The application will need to address the above points.
6.3.7 - Industry Categories
Assets that are used in specific industries have been listed under their various industries. Some assets are used mainly in just one industry and these assets are listed under that industry category. Therefore craypots, for example, are listed under Fishing.
Some assets are used in a variety of different industries in a variety of different ways. Such assets are listed under two or more industry categories. For example, capping machines are listed under the category of Brewing, winemaking and distilleries and also under Chemical plant and Pharmaceuticals. The depreciation rates for capping machines used in these different industries are not the same because the capping machines are used in different environments for each industry.
The Inland Revenue website search engine (calculator for depreciation) is very useful for locating the appropriate depreciation rate using a key word search.