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Rental Properties

Investments in rental properties have proven to be very attractive to New Zealand taxpayers if the surging growth in this area is anything to go by. If you are considering buying an investment rental property there are a number of issues to be aware of.

A number of people are buying investment rental properties with a view to building a portfolio of property for their retirement.

It is very important that these investments are structured correctly to make them tax effective.

In some instances, interest is not claimable against the rental income because the loan and ownership have been structured incorrectly.

In a recent case, a taxpayer purchased a second property to live in, borrowing funds to finance the purchase. The first property was rented out. The taxpayer tried to claim interest on the residential house loan against the rental income. The interest deduction was disallowed because the funds were not used for the purchase of the rental property.

This transaction could have been structured differently and the interest could then have been legitimately claimed against the rent.

Deductions

  • Where you occupy a rented private dwelling-house and a portion of that house is used for business purposes (eg, musicians, doctors), a proportionate part of the rent may be claimed as a business expenses
  • Where property has been purchased for the purpose of re-selling, any profit from rental income is taxable
  • Expenses such as rates, insurance, and repairs (less any casual rents) pending sale are deductible from the gross rentals
  • Expenses applicable to the property are deductible even though the property may be temporarily vacant
  • Where the property is held for realisation and the property returns casual rents, the expenses are deductible only to the extent of the casual receipts
  • Where property of an estate is held for letting at an adequate rental with a view to subsequent realisation, the expenses are allowable up to the rents received
  • Whether or not the excess expenditure is allowable depends on whether such expenditure is incurred primarily for the purpose of securing rents during the period or is incurred primarily for the improvement of the property

Repairs and Maintenance
Repairs and maintenance expenses are only claimable if the repairs were carried out while the tenant was still living in the house or the house was still available for renting.

Often overseas owners returning home realise the damage done to the property after the tenants have moved out – and because of the change to private use, Inland Revenue may not allow a claim for repairs of such damages. There have been instances in the past where such claims have not been allowed.

Rental Expenses from 'own-your-own' Flat or Office Allowable
You can claim expenses if you occupy an 'own-your-own' office or get income from letting an 'own-your-own' office or flat.

Usually, the company formed to own the building levies its shareholders for their share of the rates, insurance, maintenance, and other outgoings. Sometimes the levy includes a charge for depreciation, but when it does not, the owner-occupier still makes a claim at the appropriate rate on the share of the cost of the building.

Employers who take up shares in 'own-your-own' flat companies to get accommodation for employees are entitled to depreciation on that part of the cost of their shares in the flat-owning company which relates to the building, in the year first used.

When capital improvements are made later, the cost should be added to the cost of the building for calculating depreciation. The 'cost of building' that is calculated will then be apportioned to each owner-occupier in the proportion that their shareholding bears to the total shareholding in the company.

Property Leased for Inadequate Rent
Where property is leased for an inadequate rent, or the lease makes no provision for payment of rent, IRD may determine what is an adequate rent for that property and the amount is deemed to be income derived by the lessor. This applies where:

  • The lessee is a relative of the owner of the property, or of one of the owners (if the property is jointly owned), or a relative of any member of a partnership which owns the property
  • The property is leased to a company under the control of the lessor or any relative of the lessor, or under the control of any one lessor or a relative (where there is more than one lessor)
  • The property is leased by a company to any person

LTCs (Look through company) 

An LTC (Look Through Company) exists for tax purposes only. An LTC retains its identity as a registered company and is therefore still governed by the Companies Act.

To become an LTC, a company must meet all the eligibility criteria for the whole of the income year. If there is a breach, the company cannot use the LTC for that tax year or for the two tax years following.

  • Generally, an LTC's income, expenses, tax credits, gains and losses are passed on to its owners. These are allocated to owners in proportion to the number of shares they have in the LTC. Owners can also deduct expenditure incurred by the LTC before they became a member, if they pass certain tests
  • Any profit is taxed at the owner's marginal tax rate. The owner can use any losses against their other income, subject to the loss limitation rule
  • The loss limitation rule ensures that losses claimed reflect the owner's economic loss in the LTC
  • The owners of an LTC are treated as holding the LTC's property directly in proportion to their shareholding. When owners sell their shares they are treated as disposing of their share in this property and may have to pay any tax associated with this, if certain thresholds are exceeded
  • If the LTC ceases to exist or becomes an ordinary company, the owners are considered to have disposed of their shares at market value
  • Look-through applies for income tax purposes only. Under company law an LTC retains its corporate obligations and benefits, such as limited liability
  • An LTC is still recognised separately from its shareholders for:
    • GST (goods and services tax)
    • PAYE and employer tax responsibilities
    • FBT (fringe benefit tax)
    • RWT and NRWT (resident and non-resident withholding tax)
    • ESCT (employer superannuation contribution tax) and
    • RSCT (retirement scheme contribution tax)
    • The income tax rules for company amalgamations

The main Advantage of being an LTC

An LTC may be a popular entity for certain small enterprises because losses can flow through to a shareholder.

The main disadvantages of being an LTC

Profits are taxed at the marginal rate not the corporate rate. And of course there are the usual costs related to statutory compliance for companies.

See us First 

Please contact us for tax implications that may arise from a purchase or transfer of investment properties.
 
Disclaimer
Important: This is not advice. Readers should not act solely on the basis of the material contained in this fact sheet which consists of general comments only and do not constitute or convey advice per se. Changes in legislation may occur quickly. We therefore recommend that our formal advice be sought before acting in any of the areas. We believe the contents to be true and accurate as at the date of writing but can give no assurances or warranty regarding the accuracy, currency or applicability of any of the contents.


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