Claiming depreciation on buildings - how proposed policy changes could affect you

Whether non-residential buildings should be able to be depreciated for tax purposes has been a contentious issue for many years. The ability to claim depreciation was first removed in 2010, but then reinstated in 2020 as part of the Government’s COVID-19 Stimulus Package as a permanent measure (or at least not as a temporary one). This law change also gave building owners’ tax relief on seismic strengthening expenditure, which was previously unavailable. However, in the latest twist, the National Party, which will lead New Zealand’s next coalition government, has announced its intention to remove depreciation on buildings. Importantly, there is no suggestion that depreciation deductions for fit-out will be removed. 

If enacted, this law change would be a disappointing development for building owners and investors for a number of reasons. Property Council New Zealand (PCNZ) has raised deep concerns about the impact on forward investment in ageing building stock and increased costs to businesses who occupy these buildings. Indications of proposed changes to the rules create uncertainty at a time when landlords are facing rising costs of insurance, higher interest rates, and significant capital expenditure requirements for sustainability initiatives. Many decisions made since 2020 to strengthen, upgrade, develop or acquire commercial property, will have factored in depreciation deductions and, should the changes be made, marginal investments may now be at risk. 

In the residential sector, given the challenges with housing affordability in New Zealand, an empowered ‘Build-to-Rent’ sector could give the housing supply a significant, timely boost. Allowing depreciation is one of the policy settings that could help to support the scale of development that would contribute to alleviating our housing shortage. These types of developments do not currently benefit from depreciation deductions, and many in the industry were hoping for favourable law change in this area.

Yes, they do. In 2018, the Tax Working Group did extensive international research into whether buildings do decline in value. They found strong evidence that industrial and commercial buildings do depreciate, with some evidence that residential buildings (particularly multi-unit properties) also depreciate. This led to the recommendation that tax depreciation for commercial, industrial and multi-unit residential buildings be made available at 2% p.a. (straight line method) and 3% p.a. (diminishing value method). This recommendation was partially reflected in the 2020 law change – depreciation was reintroduced, but the rates were reduced to 1.5% straight line, and 2% diminishing value. Multi-unit buildings which are residential in nature are only depreciable in very limited circumstances. For example, some student accommodation or specific areas of retirement villages.

It is important to remember that fit-out within a building can be depreciated separately to the building itself, and there appears to be no proposal to change this. Expenditure on structural elements or weatherproofing is normally considered to be ‘building’ but other expenditure is generally viewed as fit-out. These tax rules can differ from traditional concepts in the real estate industry in terms of how these two aspects are defined. 

Fit-out assets have shorter life expectancies than buildings and structures. With their higher depreciation rates, they generally make up a larger share of annual depreciation deductions than for ‘buildings’, for example in relation to commercial offices or modern warehouses. The availability of optimised depreciation allowances for building fit-out is dependent upon a detailed allocation between almost 100 IRD categories. Allocations should be made upon the initial development or acquisition of a property, or the subsequent capital expenditure, to accurately set opening book values. 

If you are a building owner who does not already have an independent valuation to support fit-out depreciation deductions, you should consider whether it is beneficial to obtain one, particularly in relation to recent purchases or capital expenditure. 

If you are in the process of buying a building, the purchase price allocation you adopt is more important than ever, and you should ensure you seek appropriate tax advice.

If there is law change, there will also be tax accounting consequences you will need to be aware of. 

Taking advantage of PwC’s integrated Real Estate, Tax and Legal service offering can assist you to maximise opportunities for value. Please contact your usual PwC advisor, who can link you in with our team.