What is the change?

The Government is removing the ability to depreciate commercial and industrial buildings from the start of the 2024/25 income year (1 April 2024 for most taxpayers).

This will support the Governments fiscal requirements and is estimated to generate $2.31 billion over the forecast period 2024/25 to 2027/28.

Since residential buildings are currently not depreciable for tax purposes, this would apply the same tax treatment to all buildings used for investment or business (other than certain short-lived buildings with an estimated useful life of less than 50 years).

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What is depreciation?

Depreciation is the decline in market value of an asset over its useful life due to wear and tear, ageing and becoming outdated or obsolete. Depreciation is calculated based on a rate predetermined by the IRD. The standard depreciation rate for buildings with an estimated useful life of 50 years or more is 2% under the diminishing value method or 1.5% under the straight-line method.

Depreciation is a non-cash item; no money physically changes hand. For tax purposes, depreciation reduces the taxable income by the annual deductible allowance allowed over the asset’s useful life.

Allowing depreciation on commercial buildings creates a timing difference for tax where the future sale of a property at or above its book value. If a property is sold for more than its tax book value (being cost less accumulated depreciation) then this results in taxable income referred to as depreciation recovered.

Simply put, depreciation is a timing benefit only.

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A commercial property or any property comprises land, building fit-out, plant and equipment and the buildings themselves.

• Land cannot be depreciated.

• Building Fitout and Plant and Equipment have always been able to be deprecated – this will not change.

• Building depreciation rules have changed several times over the years:

- Buildings were able to be depreciated until 2011

- Then not able to be depreciated between 2011 and 2020.

- In March 2020, building depreciation was reintroduced as part of the Covid-19 response package.

- And now again, from 1 April 2024 we can no longer depreciate buildings.

Buildings are different from Building fit-out or Plant and Equipment. Fit-out are items that are separated for the building i.e. Air conditioning or HVAC units, Doors, Curtains, Blinds, Carpet, light fittings etc. These individual assets have separate depreciation rates and are still subject to depreciation rules.

Plant and equipment include computers, IT equipment, furniture, machinery, surgical or medical equipment. Again, these assets have separate depreciation rates and this will not change.

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Impact on distributions

Depreciation on buildings can make up a substantial deductible expense for tax purposes. By removing this expense, the taxable profit increases, and hence, the tax to pay increases. Tax is a real cost to investors, reducing the net (after-tax) return for investors in commercial property.

As each investor has a different structure and tax rate First Light quotes all returns on a pre-tax basis.

• For the PIE Funds tax is capped at 28% and distributions are paid after tax. Monthly distributions will decrease with the removal of depreciation on buildings as tax is deducted at source.

• For the LP Funds, distributions are paid pre-tax. Partners pay tax based on their individual marginal tax rates. The distributions will not change however, you will likely have to pay more in provisional or terminal tax.

First Light also works closely with VCFO Group to maximise investors pre- and post-tax returns. If you need any assistance managing your tax affairs, please reach out to Andrea Leeper andrea@vcfo.co.nz or VCFO directly.

For long term investors in commercial property, the removal of tax depreciation on buildings will mean that the taxable component of their investment will increase, i.e. the amount of tax they pay on their investment will increase. Nevertheless, in the year of sale, a wash-u calculation is completed so deprecation is a tax timing benefit only.

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