Deductability of Due Diligence Costs when Purchase does not go ahead

[SwissKiwi]

Hi Team,

I spent money on lawyers/building inspection etc on a commercial property which I ended up not purchasing.

The accountant says these costs are not deductable for these reasons:

"Preliminary expenses are neither incurred in carrying on a business or in deriving assessable income. Therefore these expenses will not satisfy the nexus test for deductibility under section DA1 of the Income Tax Act."

I was a bit suprised by this - does anyone have any other information or is this just the way it is?

Cheers,
SK

[TheLiberalLeft]

I think that's bollocks, but it depends on your circumstances. If your business is the buying and selling of commercial property (ie you're not a long term buyer/holder) and you're GST registered for that business (not that that is particularly relevent but does strengthen your case) then the expenses surrounded a failed purchase are absolutely part of your "carrying on a business".

But I'm no accountant.

[Rosco]

Your accountant is kind off right if you are a long term holder. If a trader, then would be claimable.

Basically inspection etc would all be a cost of the property, and not claimable as a 100% expense, even if the purchase did go ahead. This is the capital limitation DA2, Capital limitation

(1) A person is denied a deduction for an amount of expenditure or loss to the extent to which it is of a capital nature. This rule is called the capital limitation.



With legal fees, they are a little different and there was a change a year or two back. see section DB 62 http://www.legislation.govt.nz/act/p...LM1952984.html

I think the legal fees could meet the general permission in DA1, but it does depend on your circumstances. If the purchasing entity owned other investment properties, and is in the business of renting, then I think there is enough of a relationship to claim the legal fees. This is subjective and not a black/white issue.

Ross

[KyronGosse]

The way I understood it when it was explained to me is that if you already own property then you are in the business of owning properties then all property related expenses can be expensed. If you do buy the property then it would be considered part of the cost of buying property and therefore can't be expensed.

If you do not own any property and you fail to purchase then you can not expense it as you are not deemed to be in the business of property.

This also applies to education, travel costs, research costs etc

But then I'm no accountant either

[Davo36]

Yep, Sk, your accountant is right.

It's surprising isn't it? You'd think if you were in the business of owning properties, these would be expenses.

But the IRD thinks otherwise...

[spaceman]

There was an accountant on here a while back who answered this question and provided the relevant rules in a pdf.....I'll see if I can dig them up.

The upshot as I see it is this.

If you're already in business then prospecting costs are claimable.

If not in business the the income nexus hasn't been met yet so all initial prospecting costs must be capitalised as part of the final purchase price.

In your case you don't make it clear how you're going to structure this potential purchase....if the intent was to add to an existing business then I would say your accountant was wrong.......If the intent was to buy it as a completely separate entity then I would say that the accountant was correct.

Cheers
Spaceman

[SwissKiwi]

Appreciate the info guys, I had thought this was a clear case of a business expense.

ie:
In the business of leasing/renting property, due dilligence on a prospective purchase is a cost of being engaged in that business.

I don't really see the rational behind why this should be a grey area, but you learn something new everyday!

SK

[Rosco]

Appreciate the info guys, I had thought this was a clear case of a business expense.

ie:
In the business of leasing/renting property, due dilligence on a prospective purchase is a cost of being engaged in that business.

I don't really see the rational behind why this should be a grey area, but you learn something new everyday!

SK

As you have put above, you are in the business of leasing / renting property. NOT, in the business of buying property. So expenses relating to leasing / renting your current properties are claimable, but expenses relating to a new venture are different.

Do ask your accountant about the specific legal expenses if under $10k per year!

Ross

[KyronGosse]

I don't really see the rational behind why this should be a grey area, but you learn something new everyday!

SK

I'm not sure rational and IRD could be used in the same sentance

[halfempty]

Surely these cost's would be claimable if you were a buyer and seller of property as a taxable activity.

But as an investor they would be treated the same as pre incorporation expenses like setting up your company and taking advise.

If you can't claim them this round then surely you could claim these costs against your next purchase because "Not" buying this property was in instrumental step in completing the next transaction that did become in income producing taxable activity.

[spaceman]

LOLZ ......got a chuckle out of some stupidity in another thread......couldn't find the original PDF supplied by the accountant.

But this is probably worth a read

http://www.ird.govt.nz/technical-tax...08-is0802.html ......or you could hunt for the thread where I was mean to some "accountants"

Cheers
Spaceman.....EDIT

Found the original post ......perhaps the offer of an email reply still stands, but the post was from 2006

masteraccountants
Freshie

Join DateSep 2004LocationAucklandPosts87

Hi Guys,

IRD have issued a Ruling and Statement on this question. It is IS2783 "Deductibility of feasibility expenditure".

As long as you in the business of rental property investment, the costs of researching and finding properties is claimable as an expense up to the point where you commit to buying a property. Anything after that point has to be capitalized against the asset purchase.

If you want a copy of the CCH opinion on this topic, just email me so I can attach it to an email reply.

Christopher Raynal
Master Accountants Group Limited
www.masteraccountants.co.nz

[Bluekiwi]

From a rental property perspective, what is also dangerous these days, is that you can make a cash loss through the year and also make a profit and be taxed.
What I like to call negative negative gearing or blackhole expense accounting.

Where you have to replace or fix something that has broken or needs upgrading or the tenants has destoyed.
And because you decide to do a proper job and put something decent in for them, this is not just an expense but a capital improvement - that cant be depreciated now, nor can be an expense item.
You incur enough of these, in addition to other expenses the are business related but not directly related to the production of rental income.
There are enough of them out there.

And you can make a cash loss for that property through the year.
But as these other "Costs" cant be included in the P and L, you actually make a profit.
And then you get taxed on that, and actually have to then pay out to IRD, making more cash loss's.

Negative Negative gearing, the new thing in rental property, get into it

[Rosco]

Surely these cost's would be claimable if you were a buyer and seller of property as a taxable activity.

But as an investor they would be treated the same as pre incorporation expenses like setting up your company and taking advise.

If you can't claim them this round then surely you could claim these costs against your next purchase because "Not" buying this property was in instrumental step in completing the next transaction that did become in income producing taxable activity.

- It has already been answered above that a property trader (someone who buys and sells property for a profit) could claim these expenses.
- Sorry you are wrong about claiming these next time around. They will still be capital and non deductible.

Ross

[craynal]

Your accountant has told you the basics - that preliminary expenditure is not claimable - and appears to have left it there. He has not given you any options by saying, for example, "now if you had...then it would have been claimable". If you did not ask him how it could be claimable, then it is a double tragedy.

What appears to be 'preliminary expenses' sounds to me like it could have been reclassified as 'feasibility expenditure'. This is covered by IRD Interpretative Statements IS 2783 that seems to have morphed into IS 0802. And then it would have been claimable...with some caveats.

As long as you or an entity were 'in the business of property investing', so you do not need to be a trader of some sort, then the feasibility expenditure is claimable. The feasibility expenditure only has to be capitalized to an asset once there is a commitment to purchase, so from that date and afterwards.

If you already were an investor in property, residential or commercial, with a view to making assessable income, namely rental income or development income, then the feasibility expenditure is claimable. If you were not 'in the business of property investing or development', then you could look at some options for commencing an entity to carry on that business. Then it would be easier to evidence that you were in the that business. It is more difficult to evidence it if you are saying you are doing it on your own account. An entity has a commencement, and it can be said that the business started with its formation.

Your choices are a company - an LTC so you can claim the expenditure/loss against your personal income - and a Trust. If you had started the LTC before the end of the financial year (31/03/13), then you could have made the claim in your tax return for 2013. A company can ratify pre-incorporation expenses, so the feasibility expenditure would fall into that category. If you start the company now, then the expenditure will be claimable in the year to 31st March 2014.

A Trust is another entity that could be used. A loss made in a Trust cannot be transferred out to another person or entity. If investments are made, then there are options where the losses can effectively be transferred out of the Trust. And the feasibility expenditure could be included. It is problematic. The LTC is the easier and surer option.

[Wayne]

Great 1st post Craynal. Welcome to the fold.