Claw back of depreciation claimed

[donna]

Umm been thinking about this for a wee while and I must admit I still haven't really got my head around the 'claw-back' of depreciation claimed when you sell a property. I mean - why do you have to pay back depreciation claimed if in deed the property and chattels have depreciated (as per the schedule) and therefore are no longer the value they were when you purchased the property?

The profit we make on selling a property is increase in land value (is my understanding) as land appreciates and building etc depreciate. And if the depreciation schedule of a chattel is 10 years for most items - if you sell at year 9, what do you have to pay back?

Is this the same for other businesses - if you stop trading, do you have to pay back the depreciation claimed on your capital assets (computers, office equipment etc) - all $$ claimed?

[Gerrard]

The claw back is about recognising what the current value of an item is at the time you sell it.

If you buy a computer for your business, depreciate it for 2 years then close the business down, there is still a "book value" for that computer (i.e. an asset of some vaue owned by the business). If you sell that computer for a different value to what's on the books then the difference must be accounted for. This will mean an extra depreciation writeoff if you sold it for less then book value, or a clawback if you sold it for more.

Exactly the same applies to buildings and chattels.

The profit we make on selling a property is increase in land value (is my understanding) as land appreciates and building etc depreciate.

That's probably not IRD's understanding! When you look at rating valuations you see that BOTH the land and improvements change over time.

Big disclaimer: I'm no accountant. This is just my simple view of the world.

Gerrard

[RentMaster]

You are right that land does increase over time. The question is, how much of the increase in sell price is an increase in land value?

If you get a registered valuation and chattels valuation done prior to sale, on there they can tell you the value of the land, improvements and chattels. Any improvements or chattels which are valued higher than their book value means that you have claimed more depreciation that you should have, and so you have to pay it back. Any increase in land value is fine.

If you do get a valuation done, it is a good idea to tell the valuer you are selling the property, and that is why you want the valuation done.

[donna]

That's awesome - thanks a lot for those responses. And what you are saying is the claw-back only applies to the depreciation claimed per item? So if you had a dodgy old kitchen as part of the depreciation schedule where none of it was claimable then you decided to renovate (add a new kitchen) before you sold, because you hadn't claimed any depreciation on the kitchen then there's nothing to claim back? Umm - I'm not out of the woods on this issue yet I think.

[casacamo]

You can get a good idea of the land value increaess
form your Council Valuation notice.
Auck. City lists land value & improved value separately.

Casacamo

[Warren]

Man, you miss checking in on the forum for a couple of days and see what you miss, Muppets 1,000th post (congratulations) and other issues dear to your heart (like depreciation!)

Clawback is an issue for all investors that claim depreciation on their IP. In the market that we have experienced in the past 18 months clawback has been an issue due to the significant increase in the prices of properties. Which begs the question - if I am going to have to pay clawback should I bother claiming depreciation at all in the first instance. The answer is yes. And here is why (I will ignore the obvious benefits of claiming depreciation and concentrate solely on the clawback issue)....

By having the apportionment completed upon the purchase of the property the investor has a full breakdown of the property components. This includes items such as carpets curtains, light fittings etc. These items do depreciate and this can be proven to the IRD and is therefore allowable and depreciation is NOT recovered. With a full breakdown of chattels and values provided from day one by an independent third party it then becomes difficult to argue that the items have increased in value.

It is possible to minimise the amount of any recovery tax. We are aware that some accountants recommend that itemised book values be attached to the back of the Sale and Purchase agreement at the time of the sale. If the purchaser signs off on these values - an independent third party has agreed to the values (purchaser) therefore setting the market value of the chattels. HOWEVER we are not aware if the IRD has made a specific ruling on accepting these but we are aware that some investors have used this approach. If an investor is purchasing the property they are then bound to these values and they may not be able to maximise the depreciation that they may have otherwise been able to claim.

Another way you may be able to minimise the depreciation recovery is as suggested by RentMaster by proving the increase in the property value is actually in the land value and obtain a registered valuation etc.

If you do end up by selling the property and having to pay claw back tax then at the very least the use of the money by you can be viewed as an interest free loan from the Government. Not many people would turn this down.

At all times we recommend that you talk to your financial advisor and "property team" before selling any property to identify any potential issues.

what you are saying is the claw-back only applies to the depreciation claimed per item?

That is correct.

So if you had a dodgy old kitchen as part of the depreciation schedule where none of it was claimable then you decided to renovate (add a new kitchen) before you sold, because you hadn't claimed any depreciation on the kitchen then there's nothing to claim back?

There appears to be a couple of issues in this.

Even a dodgy old kitchen has some value to it when you purchase the property. The purchase price reflects what the purchaser and seller believe the property is worth. If the kitchen had been in a better condition then the purchase price would have been slightly higher to reflect this. Even if an independent third party had, in basic terms, put a total value of $1,000 on the kitchen it would still be worth claiming depreciation on this as every dollar counts! The kitchen is made up of many different components that have different depreciation rates and estimated life spans. In general terms the depreciation rates can be anywhere from 4% to 50% in a dodgy old kitchen. The IRD provides estimated life spans for all chattels and the depreciation rates reflect these estimated life span (depreciation is an acknowledgement of wear and tear on the asset over its life pan). This means that it can take up to 50 years before the asset is fully depreciated in a house.

The points to be aware of are as follows:

1. You can claim depreciation on old worn out chattels from the day you purchase the property.

2. The IRD life span of the various components can be up to 50 years before the chattel reaches its minimum residual value.

3. You need to claim depreciation from the first tax year on the whole property. The IRD rules stipulate that you must declare the property as a depreciating or non-depreciating asset from the first tax year. You cannot decide that because the property is so run down that it is not worth claiming depreciation and then renovate, increase the value of the property, and decide that you want to claim depreciation.

4. If you have a full apportionment completed from day one you will have a breakdown of the actual value of the chattels. When you renovate your accountant writes off the book value of anything that you have removed and receipts in the new chattels at the receipt value. You then claim depreciation going forward on the receipted value. If you did not have a full-itemised breakdown of the chattels at the start how would your accountant know what value to write off for the kitchen? The answer is - they wouldn't know what the value of the old kitchen was. They would take a conservative guesstimate, which is not necessarily in your best interest.

I hope this assists.

regards

[donna]

Wow that was awesome Warren - and I'm screwed on one property as building and chattels were both depreciated at the default 4% on the first tax return, but I won't be making the same mistake on the subsequent IPs.

Thanks for that - will be using Valuit too.

[Warren]

Donna,

Yeah.. I was surprised at the length of the response as well (I may not have the award for the number of posts but perhaps for length?). As an investor Valuit believe you should have full information and it is great that we are able to assist the PT community.

My suggestion would be to talk to your (specialist) property accountant about your first IP.

I am aware that some accountants will talk to the IRD about "correcting" returns that have already been filed. There are positives (for example you can maximise the depreciation going forward) and negatives (you may be hit with clawback for the years that you have already filed).

This depends on your own individual situation (how many years you have owned the property, extent of any renovations, investment strategy etc. etc.).

If your accountant is happy to do this (re-file) give the local Valuit representative (or myself) a call and we can discuss the issue further.

regards

[artemis]

Thanks Warren. I've just used Valuit for a chattels valuation - very professional all round. (Free plug!) I've used another firm in the past, they definitely don't deserve a free plug. How about - the other firm forgot to include the washing machine and drier. Hard to miss in a 3 room flat. But they did.

I have had excellent value from chattels valuations in the past. In all cases they pay for themselves plus a heap in the first year.

Here's a small tip. I figure it is worth settling on a property as close to the end of the month as possible, as for depreciation purposes a part month is counted as a whole month. So, settle on the 31st instead of the 1st and you get an extra 1/12th depreciation in year one.

As Warren says, every dollar counts ...

[masteraccountants]

Depreciation Recovered

Hi,

I was hoping that Warren of Valu-It would give himself a better plug and advise that you to do a chattels valuation when you purchase the property and when you sell the property - just before vacating as the new owner may not allow access to the valuer.

The second valuation will prove that most of the increase in selling price has come from the land rather than the building. What this means in practical terms is that the depreciation clawback is reduced HEAVILY.

Our experience is that clients have been able to peg back the depreciation recovered by up to 50%! So they only paid back half of the depreciation claimed over the years, and they had an interest free loan benefit also. Not a bad deal!

So should you not claim depreciation because you're afraid of paying back depreciation recovered? You don't have to be Einstein to figure out that one!

Chris

https://www.masteraccountants.co.nz

[/url]

[Kirks]

Wow - I have so much to learn!!! Coming from the UK where the depreciation thing just doesn't exist its quite overwhelming trying to take everything in. Thanks a million to all you helpful people who put explanations into plain english - it's such fantastic help.

Regards

Kirks

[Warren]

Thanks to Artemis and Masteraccountats for the plugs. It is great to get such positive feedback.

Yes we do do chattel valuations when the investor is selling an IP as a mechanism to assist in minimising any clawback tax. However we have found that in some instances this may not be the most effective way of assisting the investor to minimise any claw back tax. Where we believe this may be an issue we discuss the matter fully with our clients before we undertake the chattel valuation. If in doubt call us.

What we have found generally that throws the spanner in the works is a combination of two things.

Firstly with the significant increase in the property market recently we often have hundreds of thousands of $$$ additional to apportion over the dwelling when the property has been sold. For example if the house was original purchased for $200,000 and has now sold for $325,000.

The second thing is the registered valuations that form a base for some of our calculations. We have to use the most recent valuation at the time of purchase and when you sell, the most recent valuation at the time of sale (This can be a private registered valuation or the rating valuation). Any significant differences in the split between the land value and market value in these two valuations (as a ratio) can cause problems. What generally happens is that some items will decrease in value but others can increase in value significantly.

Interestingly enough in the Discussion Document that was released in July (and submissions closed on yesterday) by the IRD and Treasury one of the things that has been mooted is that if you have a full apportionment when you purchase the property then you will require one when you sell the property. We have raised in our submission the discrepancies that can arise when a chattel valuation is completed upon the sale of the property.

Kirks, great to see hear that you are learning so much from the forum. If you have any questions please ask!

Regards

[artemis]

In Harcourts Sep 04 Rental Property News they say:

"The depreciation rate is to be lowered, quite probably with effect from 1 April 05."

It goes on to talk about 'the proposals'.

Do they know something we don't?

The newsletter also says the Govt has announced depreciation will be clawed back by IRD on rental properties transferred as part of a deceased person's estate.

Has that been passed into law?

[muppet]

Hi Artemis

Listened to Dr Muriel Newman at the HBPIF meeting on Thursday night and she intimated that the new depreciation rules will be up for voting on in November with implementation from 1 April 2005.

The Govt appears to acting with great haste on this but it is only one part of new tax laws.

The Govt also appears to not like propoerty investors. The tail ia also wagging the dog on this one. (The Green Party and the United Party)

Of about 60 members at the meeting only about 5 had made a submission.

There about 164000 property investors which is a sizeable lobby group. Not enough of them are protesting.

A capital gains tax has been ruled out in the meantime but watch this space.

And finally it sounds as if the IRD will be able to claw depreciation from a deceased person's estate. But I think that will depend on how that person has structured their buying of IPs.

Please check out http://www.depreciation.co.nz and sign the petition that Muriel Newman has set up.

Regards

[fudosan]

Firstly with the significant increase in the property market recently we often have hundreds of thousands of $$$ additional to apportion over the dwelling when the property has been sold.

For investors holding a property for over 10 years and then sell, we will very likely see significant increase in the price. Does it mean for long-term investors we should not bother doing chattel valuation? Can you be more specifc on situations where chattel valuation is not worth it?