If you’ve got rental or investment properties, then you need to know about the changes to property depreciation and LAQCs from 1 April 2011.
What’s happening from 1 April 2011?
The 2010 Budget was billed as the biggest tax reform in 25 years. While the drop in the personal tax rate was one of the key headlines, there are some important changes to the building depreciation and LAQCs (Loss Attributing Qualifying Company) structure that take effect from 1 April 2011.
New property depreciation tax rules
Let’s deal firstly with the new tax rules around building depreciation. These rules will affect you if you’ve been claiming annual depreciation at a rate of up to 3% of the purchase price of your building. From 1 April 2011, that rate drops right down to 0%, in other words you will not be able to claim depreciation on the purchase price of your building.
You’ll still be able to claim depreciation on fixtures and chattels (like carpets, curtains, stoves, fridges, dishwashers or furniture). But here’s the catch. You can only claim depreciation on fixtures and chattels if you’ve already been separating them out from your depreciation claim on the building purchase price.
Claiming depreciation on chattels
Let’s say you purchased a rental property, for example, with a building cost of $100,000 and it came with curtains, carpets, a fridge and stove. If you’ve been putting in an annual depreciation claim that included those chattels with the $100,000 you paid for the building, then you can’t retrospectively separate out the chattels from the building cost and claim depreciation on them from 1 April 2011. However, if you purchase new fixtures or chattels after 1 April, such as a stove, you can start claiming depreciation on such fixtures or chattels it straight away, as long as the items cost you more than $500.
The IRD ‘clawback’ (their word, not ours!)
What if you’re thinking of selling that rental property? This is where the IRD may claw back those tax savings you’ve enjoyed over the last few years. Take that building that cost you $100,000. If you’ve claimed $20,000 depreciation over the years and you sell the property at $150,000, then you’re likely to have to pay tax. The actual amount of tax you pay will depend on how of much of the total sale price relates to the building.
What about the changes to LAQCs?
There are about 150,000 LAQCs in New Zealand. It’s likely if you’re reading this article and you’ve got a rental property, that the property is part of an LAQC. The advantage you’ve enjoyed with this structure is that the company can make a loss on the books and you can claim back that loss against your regular income. In other words, you get personal tax rebates. Any profits earned by the LAQC are taxed at the company tax rate, which is often lower than the personal tax rate.
This is all changing from 1 April 2011. You can still set up a company to manage the rental property, which often suits people if there is more than one person who wishes to own a property If the new company chooses to become a ‘Look Through Company’ (LTC) it will be taxed like a partnership. So any profits will be treated as belonging to each shareholder in proportion to their shareholding in the company with tax paid at each shareholder’s marginal tax rate, rather than the company tax rate. Losses may also be treated as belonging to each shareholder, however there are limitations around this and your accountant or tax advisor is the best person to talk to.
What do you need to do?
The current LAQC structure finishes on 31 March 2011, and there are specific rules in place to minimise the tax payable during the transition to the new structure. You’ve been given 2 years to decide what the best structure will be for your situation. However if you don’t file an election with IRD within the first 6 months of the new rules (generally by 30 September 2011) you may lose the ability to offset tax losses incurred in the 2012 tax year.
It’s important you understand the changes and the best person to talk to is your accountant or tax advisor. You may find there is a cost involved for any changes you need to make. Talk to your Roost Mortgage Broker if you need to make any changes with your LAQC loans.