Bank Loan Approvals – a word of caution

I wrote the bones of this post in 2013, but its even more relevant now with stories of banks reneging on loan approvals just as the unit settlement date approaches.

Basically:  Bank loan approvals mean very little if anything especially when buying apartments/housing off the plans.

You may think you can go and make your offer in safety.  You really can’t.

All bank loan approvals are “indicative”…ie they merely indicate what the bank “might” be prepared to lend under their present policies AS AT THAT MOMENT.  They all have language which lets the bank pull back from the loan if their policies or circumstances change and relieve it from any responsibility at all.

It leaves the purchaser in a dreadful position, facing possible bankruptcy, and unlikely to have any recourse against the Bank concerned.

Anyone who doubts this can talk to the hundreds of people that bought apartments off the plans in 2006-7, only to find that when the apartments were completed, their bank reneged on the loan approval, changing (for example) from 80% of purchase price to 65% of the then current valuation (which had of course dropped substantially due to the global financial crisis)….assuming they were willing to lend anything at all.  Many of those people were unable to settle and were sued by the vendor (more often the receivers put in by the vendor’s bank).  Some are now bankrupt.

Banks are not your friend.  They are not loyal.  They will not make a loan they now deem to be a danger, and will not be concerned at the consequences to you.  They will not take a risk on your behalf and, to be fair, neither they should.  But what they should do is be more up front that their indicative loan approvals are not worth the paper they get printed on.  Buyers beware….especially buyers that are entering into long term sale and purchase agreements, where it is difficult if not impossible to forsee the bank’s lending criteria when settlement comes due.

You need some idea of what you can do if the bank won’t lend as much as you thought they would…whether bridging finance, or family support, or other property you can use as security.  Having no plan risks disaster.

Posted in Banking & Finance, Commercial Property, Construction Law, Litigation, Property Law, Residential property, Securities Law, Subdivisions, Unit Titles | Tagged , , , | Leave a comment

How to Write a Movie Review for Women

Like this one.  Seriously, that’s how it’s done.  Hilarious 🙂

This is some of the more family friendly material…

Ok so I don’t know what the plot is or who is in it other than Alexander Skarsgard and Alexander Skarsgard’s magnificent holy abs. I don’t know what the dialogue or acting is like or whatever.
But like 1/3 of the way in Alexander Skarsgard is going to fight a gorilla for some reason and he takes off his shirt and OMG LIKE I ACTUALLY GROANED LOUDLY.
He does not put his shirt back on for the whole movie.

LOL 🙂  From the lively and entertaining EmilyWrites…

Posted in Amusement, Uncategorized | Tagged , | Leave a comment

Residential Land Withholding Tax

From 1 July 2016 we lawyers have been chosen for the honour, by the grace of her Majesty’s New Zealand Government, of becoming unpaid tax collectors for the Inland Revenue Department, whether we like it or not.

From that date we will need to deduct Residential Land Withholding Tax from the proceeds of some residential property sales and pay it to the IRD.   This is a new witholding tax that is intended to stop the perceived flight of taxable gains out of New Zealand to overseas speculators.  Whether there is actually a problem in this regard no one really knows, but few things move quicker than a government which suspects it is missing out on tax.

It’s not really a new tax. It’s more about deducting money on suspicion, ie “witholding” it, and putting it aside in the government’s bank account until the tax status of the transaction is clear.

You then have to file your returns and show the transactions, properly evaluated, weren’t taxable. You hope. If the sun shines upon you a refund may be forthcoming.

The details:

When is tax withheld? The withholding tax will only apply when the property being sold is located in New Zealand and:

  • is “residential land”
  • the vendor purchased or acquired the property on or after 1 October 2015
  • the vendor owned the property for less than 2 years before selling
  • the vendor is an “offshore RLWT person”

There are exemptions where inherited properties are being sold and for transfers of relationship property.

What is an “offshore RLWT person”? An “offshore RLWT person” is not the same as an offshore person in the tax statements introduced last year. An “offshore RLWT person” will include:

  • A NZ citizen who has been overseas for the last 3 years or more continuously.
  • Someone with a resident class visa who has been overseas for 12 months or more continuously. (Student visas or work visas are not resident class visas.)
  • Someone who is not a NZ citizen or NZ resident, whether they are in or out of NZ.
  • A company if more than 25% of its directors or more than 25% of the decision making rights are held or controlled by the types of individual persons described above.
  • A trust where the trustees or certain beneficiaries are the types of individual persons described above.
  • A limited partnership if 25% of the general partners or 25% of the partnership shares are held or controlled by the types of individual persons described above.
  • For partnerships each partner will need to determine if they are an offshore RLWT person and they then might have tax deducted from their share of the property sale income.

How much is the tax? An online calculator is available on the IRD website to help work out the amount of the tax to be deducted and paid to the IRD. This will be the lowest of:

  • 33% (except for companies which is 28%) of the gain on sale
  • 10% x the sale price
  • Sale price less rates and amount needed to discharge the mortgage (where the mortgage is with a NZ registered bank or licenced non-bank deposit taker)

Agency commissions cannot be deducted out of deposits if there are insufficient funds. Neither can body corporate levies, usual LINZ fees or conveyancing costs.

Untouchable Sales

This last bit will leave law firms in the ridiculously stupid position of having to refuse to perform some low equity conveyancing because the law firm partners would otherwise end up not only unpaid, but personally liable to Inland Revenue for more money than the sale yielded.  This has been pointed out to the government, but they have, using moderate language here that is much kinder than is deserved, “failed to take these concerns on board”.

To explain:  Let’s say there is only a small surplus on sale of an apartment, less than 10% of the sale price…because, for example, the loans are in default and the equity is getting swallowed up by mortgage penalty interest.  So the third option applies – all the sale price less mortgage repayments needs to go to the IRD.   The vendor manages to arrange a sale of its apartment that would yield it a small profit.

Yet there are body corp levies and fees to pay (less the rates component, which we can deduct), we want something for doing the conveyancing, LINZ want fees on the e-dealing, and the real estate agent has already quite properly taken their commission and marketing from the deposit, which raises an argument that under the legislation the lawyer should have prevented them from doing so until the witholding tax position was clear.

The vendor’s lawyers, if we were stupid enough to do the conveyancing, would find ourselves with a personal obligation to make payment out of our own pockets of the shortfall in the surplus to the IRD for having failed to retain the necessary amount.  We would pay the LINZ fees, levies, arguably the agents commission and marketing (the wording is not completely clear), and get paid nothing ourselves.  And let’s not forget that lawyers cannot hide behind a corporate structure – when I say personal liability, it means personal.

In practical terms, on such a sale we simply won’t settle unless the vendor funds us up front for the amount of the agents commission/marketing and other selling costs like body corp levies,  LINZ and legal fees.  If the vendor can’t pay, we won’t do the sale, and the vendor is in default of settlement.  The only option, without being funded, will be a mortgagee sale, because the costs of sale can then be included under mortgagee charges.

How unjust is it that a vendor who would otherwise come out of a sale with a small surplus, is going to be effectively forced to raise money to pay a witholding tax that almost certainly exceeds anything they could actually owe in tax, or be faced with a mortgagee sale?  That will happen.

Anyway.  Offhore vendors need to be aware that their property sales may well result in witholding tax being assessed and paid to the IRD, and will need to adjust their cashflow expectations accordingly.

Documenting your intention on purchase to hold property long term and not in the expectation of sale has never been more important.

Posted in Banking & Finance, Commercial Property, Property Law, Residential property, Tax Law | Tagged , , , , , | 1 Comment

Taxing Capital Gain – the IRD is coming for you

So.  In simple terms, people currently pay tax on capital gain if they acquired the property with the intention of resale -ie they are property traders, so profits made on resale are taxable.  Or they sell within 2 years and fall within the “brightline” test.

Most property investors, however, acquire property with two intentions.  Firstly, to hold as an investment property.  Secondly, at some point in the future to sell and take the capital gain tax free.   Maybe you, the reader, intend only to hold property as an investment and never intended selling at any point…that’s fair enough, and in commercial property that is often the case – commercial property operators tend to have a longer term view, and rent on commercial property is usually positive.

But with regard to residential property, it is my experience you would be in a small minority.  The profit in residential property investment comes overwhelmingly in capital gain which at some stage generally has to be realised by selling something, as opposed to borrowing against the capital gain to buy more property.  People look forward to the day they can cash up some of that gain and enjoy the lifestyle that goes with it, and so they should.

However, it has always been a bad idea to admit this.  It is now doubly so, with the release of the IRD’s latest consultation paper: PUB00260: Income tax – land acquired for a purpose or with an intention of disposal.

8. As noted above, an amount that you derive on the disposal of land will be income under s CB 6 if you acquired the land for a purpose or with an intention of disposing of it. But remember that there are exclusions for residential land and business premises that might apply (see [5]).

9. The key things to bear in mind in deciding if s CB 6 applies are:
What matters is your purpose or intention when you acquired the land.

  • A purpose or intention of disposing of the land does not need to be the only purpose or intention you had when you acquired the land. It also does not need to be your dominant or main purpose or intention. It is enough if disposal is one of your purposes or intentions.
  •  Disposing of the land has to be more than a vague idea or just a possibility or option in the future. You have to have a firm purpose or intention of disposing of the land.
  • The test of whether you had a purpose or intention of disposing of the land is subjective. But what you say your purpose or intention was will be assessed against all of the circumstances.
  • Evidence of what your purpose or intention was before you acquired the land (eg, during the whole acquisition process) can be taken into account.
  • The extent of commitments you make or steps you take shortly after you acquired the land may be relevant in testing what your subjective purpose or intention was.
  • The length of time you held the land may also be taken into account, and if you have a pattern of acquiring and disposing of land within relatively short timeframes, that is likely to be relevant.
  • The onus is on you to show that you did not acquire the land for a purpose or with an intention of disposing of it.


Sure, you need to have a “firm purpose or intention of disposing” of the land….but note that the onus is on you to prove you did not acquire the land with an intention of one day disposing of it, not on the IRD.Then we get to the examples, and Example 5 is also worth reading.

Example 5 – More than one purpose or intention
54. Chris purchased a property in August 2012. The property was marketed as being an attractive investment – ideal as a rental property, and expected to have “great annual capital growth”. Chris decided to buy the property to rent it out for three to five years, by which stage he hoped to be able to realise a capital gain on the property. Chris has paid tax on the rental income. He sold the property in October 2015 for a sizeable profit.

55. The 2-year “bright-line” rule does not apply to the sale of the property, because it was acquired before 1 October 2015. Even if the property had been acquired on or after 1 October 2015, the 2-year “bright-line” rule would not apply because the property was not sold within two years of being acquired. Therefore, in those circumstances it would still be necessary to consider s CB 6.

56. An amount that a person derives on the disposal of land will be income under s CB 6 if they acquired the land for a purpose or with an intention of disposing of it. A purpose or intention of disposing of the land does not need to be the only purpose or intention the person had when they acquired the land. It also does not need to be their dominant or main purpose or intention. It is enough if disposal is one of their purposes or intentions.

57. Chris was attracted to invest in the property in question because it was expected to have great annual capital growth, and could be rented out in the meantime. He purchased the property with the purpose of renting it out in the short-medium term and then selling it to realise the expected capital gain.

58. It does not matter that Chris acquired the property for more than one purpose, and disposal was only one of those purposes. When he acquired the property, Chris had a firm purpose of disposing of it in three to five years to hopefully make a capital gain.

59. Neither the residential exclusion (s CB 16) nor the business exclusion (s CB 19) apply in respect of the property, because Chris did not live in it or carry on a business from it.

60. The proceeds on the sale of the property are therefore income to Chris under s CB 6.

61. It is not relevant that the rental income was subject to tax – the Act taxes rental income as well as the proceeds on the sale of the property.

62. Chris can get a deduction against the sale proceeds for the amount he paid to acquire the property and for any capital improvements he made to the property. In each year he owned the property he will also have been allowed to deduct the interest on the money he borrowed to purchase the property, the cost of insurance on the property, and the cost of any repairs and maintenance on the property that were not capital in nature.

So…you only need to have disposal as one intention, and the onus is on you to prove you didn’t intend to dispose of the property.  There is an arguable case to be made that, in Auckland at least, every purchase of residential property, particularly those that are cashflow negative, is made with an intention of resale.

Ok, this is only a consultation paper.  However I would wager that it already represents IRD policy in practical reality.  It has a short consultation time and I expect will be acted on soon if it isn’t already.

Please note that there is a common misconception that holding a property for 10 years gets you off the hook.  It doesn’t.  That only applies where you are associated with a developer or trader and are “tainted” by that association such that a sale would be taxable.  If you hold the property for ten years, you get past the tainting.  But holding for ten years doesn’t do anything if you purchased a property with intentions that included selling in future.

Best practice, I suggest, will be for you to get your lawyer to record in a File Note that you have come to them about purchasing an investment property for long term holding, and that you intend to hold the property for future generations. Say so to them in an email.  Print and retain the email with your file on the property.  You need something to satisfy your onus to show that on acquisition you did not intend to dispose of the property, and your lawyer producing a record of a conversation where you relayed exactly that will help considerably.  It won’t save you if you’ve purchased twenty properties over the last ten years and sold them all after two years, but it will help the average investor who has built up a housing portfolio and now wants to get some personal reward.

As always, caution is the watchword!



Posted in Commercial Property, Property Law, Residential property, Tax Law, Uncategorized | Tagged , , , , , | Leave a comment

Dick Smith: Private Equity $500M, Investors Zero

I have been following the saga of Dick Smith’s receivership with great interest, not because anything illegal happened (at least, not as far as I can tell), but for the illustration of corporate raiders at work.

There is a very interesting blog piece written by the people at Forager Funds Management in October of last year on exactly how Dick Smith was purchased by private equity for $115M with only either $10 or $20 million down, the balance paid by selling written down stock and not replacing it, thereby stripping cash from the company, generated future profit through more stock sales without replacement and plant writedowns (reducing depreciation expense),  and floated Dick Smith just over a year later for $520 million in a state of low inventory that arguably caused it substantial cashflow problems as it tried to restock.

This is the article concerned.  I strongly recommend that everyone reads it.  A layperson should be able to follow it reasonably easily.

Dick Smith is the Greatest Private Equity Heist of All Time


Firstly, Anchorage set up a holding company called Dick Smith Sub-holdings that they used to acquire the Dick Smith business from Woolworths. They say they paid $115m, but the notes to the 2014 accounts show that only $20m in cash was initially paid by the holding company.

So if Woolworths got paid $115m and Anchorage only forked out $10m, where did the rest of the cash come from?

The answer is the Dick Smith balance sheet, and this is always the first chapter in the private equity playbook: pull out the maximum amount of cash as quickly as you can.

In this case, first they had to mark-down the assets of the business as much as possible as part of the acquisition. This was easy enough to do with a low purchase price. You can see in the table below, that $58m was written-off from inventory, $55m from plant and equipment, and $8m in provisions were taken.

The inventory writedown is the most important step in the short term. They are about to sell a huge chunk of inventory but they don’t want to do it at a loss, because these losses would show up in the financial statements and make it hard to float the business. The adjustments never touch the new Dick Smith’s profit and loss statement and, at the stroke of the pen, they have created (or avoided) $120m in future pre-tax profit (or avoided  losses).

Now they can liquidate inventory without racking up losses. And boy did they liquidate.

At 26 November 2012, Dick Smith had inventory that cost $371m but which had been written down to $312m. Yet by 30 June 2013, inventory has dropped to just $171m.

A salient point to note is that investors in the Dick Smith IPO would not have had access to all the accounts on the blog at the time of purchase.  They wouldn’t have seen the massive inventory and plant writedowns because these happened when the private equity purchaser took over Dick Smith.  They would, however, have seen the inventory figure.  Should they have known that this was way too low and there wasn’t enough cash to bring stock up without substantial debt?  Too hard for the vast majority, I would think.  There is also the possibility that it wasn’t too low…a low stock figure can mean an efficient and well-performing business.

That points to a very big clearance sale, and the prospectus confirms that sales in financial year 2013 were exaggerated by this. The reduction in inventory has produced a monstrous $140m benefit to operating cash flow, basically from selling lots of inventory and then not restocking.

The cash flow statement shows that Anchorage then used the $117m operating cash flow of the business to fund the outstanding payments to Woolworths, rather than funding it from their own pockets (note that the pro-forma profit was only $7m during this period).

So, business paid for.  The next task is to produce profit for the purposes of marketing a float to investors.

The big clearance sale in financial year 2013 leaves them with almost no old stock to start the 2014 year. That’s a huge (unsustainable) benefit in a business like consumer electronics which has rapid product obsolescence.

Remember that marked down inventory? Most of it was probably sold by 30 June 13 but there would still be some benefit flowing through to the 2014 financial year.

Remember the plant and equipment writedowns? That reduces the annual depreciation charge by $15m. Throw in a few onerous lease provisions and the like, totaling roughly $10m, and you can fairly easily turn a $7m 2013 profit into a $40m forecast 2014 profit. That allows Anchorage to confidently forecast a huge profit number and, on the back of this rosy forecast, the business is floated for a $520m market capitalisation, some 52 times the $10m they put in.

Anchorage were able to sell the last of their shares in September 2014 at prices slightly higher than the $2.20 float price and walk away with a quiet half a billion. Private equity are renowned for pulling off deals, but if there’s a better one than this I haven’t heard about it.

They wouldn’t have made half a billion mind you, unless brokerage etc was all paid by the company, which it may have been.  I would expect that Anchorage got less than half a billion.  But even if it were “only” $400M that is still an astounding profit.  In less than two years, on $10M down.

And the result for Dick Smith Investors?

By the end of 2014, inventory had increased to $254m, with new shareholders footing the bill for repurchasing inventory. This should have resulted in poor operating cash flow, but most of this was funded by suppliers at year-end, with payables increasing by $95m.

Come the end of 2015 financial year, however, it really comes home to roost. Operating cash flow was negative $4m, as inventory increases further and suppliers demand payment, decreasing accounts payable. The business is required to take on $71m in debt to fund a more sustainable amount of working capital. As the benefit of prior accounting provisions taper-off, profit margins fall, and the company reports a toxic combination of falling same-store sales and shrinking gross margins in the recent trading update.

Let us not ignore the possibility that the board and management of Dick Smith post-float loaded up on millions of dollars inventory that people didn’t want to buy when they could get similar or better at JB Hi-fi or others.  There is plenty of potential blame to go around.  Also, the people at Achorage Capital brought in new systems to help modernise Dick Smith and make it more efficient.  But the benefits of those systems are insignicant compared to the downstream effects from short term profit maximisation and the cash-stripping to pay for the acquisition of the business.

I really cannot over-emphasise the need for caution in all commercial dealings where people are either selling you something without full historical disclosure or having a vested interest in you buying something whether or not its a good deal.  Personally, I won’t invest in any IPO offered by a Private Equity firm.  It isn’t that there aren’t any sucessful private equity IPOs.  There are.  It’s just that they are too vulnerable to the type of strategy set out above.

Posted in Banking & Finance, Business Law, Securities Law | Tagged , , , , , | Leave a comment


We aren’t talking about lease guarantees here, where you as the tenant guarantee to pay the rent and outgoings owed by your business.

No, this post is about the sale of serviced apartments leased to the property’s manager.  I originally meant to write this on the wrong end of the last property cycle.  But then rent guarantees went away for a while, so I shelved it.  However, they seem to be coming back, and here we are.

In my opinion, they aren’t worth anything, and never were.

Oh, ok.  That’s a blanket generalisation, I concede.  I am sure that some developers do things differently from what I’m about to describe.

This post, then, covers the specific hypothetical where a property developer sells you an apartment in, say, Queenstown, that is going to be used as a serviced managed apartment chasing the tourist accomodation dollar.

The apartment is priced at $850,000 and is leased to the property manager for six years, with the first two years of rent guaranteed to be at least 6% of the purchase price.  That’s $102,000 of guranteed rent.  Pretty good, right?


Firstly, your mind is now thinking of the apartment as being worth $850,000 – because it generates $51,000 rent per annum.  But what actual evidence do you have of that?  No one is in fact leasing it for that much.  Really, you say?  You might think that some developments will go fantastically well and generate more than 6%.  Well, yes.  That is theoretically possible.  Maybe there are buildings where it has occurred.  I just don’t happen to know of any.  6% might not sound like much, but it is based on the purchase price.  If the purchase price is too high – because it has been marketed on a fat rent guarantee, for instance – then your property manager, when exposed to the real world, is in practice trying to get more like 8% or 10% per annum of the realistic apartment value.  Or more.

Once the guarantee comes to an end, nearly all of these leases will say you only get as much rent as the property manager leases it for to visitors, less expenses and the manager’s cut (which can be substantial – there is a reason that the big hotel chains just manage someones else’s buildings, they don’t own much themselves). And you are locked in, normally for at least another 4 years…but beware rights of renewal that can see your apartment trapped in a low value lease for another 6-12 years earning no one any money but the manager.  Who is usually owned by the developer, or sold by the developer to a a professional management firm.

All too often, once these guarantees come to an end the hapless purchaser finds themselves earning a return of closer to 2-3%, and the value of their apartment decreases accordingly…way, way below what they purchased it for.

You need a rental and property valuation from an independent expert as to what the room is worth, taking into account seasonal factors, the economic forecast, costs and vacancy rates.

Second.  Who is actually providing this guarantee?  If the property is being sold by A, the guarantee tends to be provided by company B, a subsidiary of A or in some way connected to or controlled by A, but to which A is not liable.  Company B may, if you are lucky, be funded for an expected contingency amount to pay out guarantees, based on happily optimistic rent and occupancy forecasts.  If, as nearly always happens, rent income doesn’t meet that mark, the funds that B has will soon be exhausted and the company liquidated.  You won’t be able to sue the directors because they had a prudent amount in hand to cover expected shortfalls based on valuation.

If you are unlucky, company B never had any substance in the first place (eg Blue Chip’s worthless guarantees), and was incorporated overseas where you have no hope of suing directors without spending large sums of money you don’t have on lawyers you don’t know in a jurisdiction that may be either corrupt or hostile to foreigners or both.

If you are very, very lucky, the rent guarantee is backed by a bank.  This is worth something but… leads on to point three.

Third, you have most probably already paid for the guarantee out of your own pocket.  If a developer decides to market apartments with rent guarantees, they simply add the cost of the rent guarantee to the listing sale price.  Let’s say the developer expects the apartments to actually make about 4% rent or $34k per annum.  The difference of 2% over two years, which is $17k pa x 2 = $34k, is just tacked on to the indicative price.  Without the rent guarantee they would have been willing to sell at $850k – $34k = $816k.  If the apartments do even worse there is some upside for you (sort of…your apartment value is still tanking, after all), but if they do better than 4% but less than 6% thanks to your own efforts, all that has happened is that you have made the developer some money.

Sometimes a developer will actually add the entirety of the rent guarantee to the purchase price, even though they don’t expect to pay all (or sometimes any, if they are intending to keep all of the money and let a guarantor fall over) of it out.  It depends what they think they can get for the apartments.  It happens more often if the apartments are being marketed in another country, where investors have less idea of New Zealand realities.


Developer rent guarantees are, far too often, unenforceable when called upon, give a false view as to the value of the apartment, and you have probably paid for them already, often in full.

You will, generally speaking, be better off negotiating a lower price and forgoing any rent guarantee.  You will need professional advice on any lease to the property manager, in particular keeping your options clear to exit if the manager isn’t performing well, and how the manager can be removed if they aren’t.

There is no substitute for an independent valuation from a competent valuer.  You must have one if you want to buy a serviced apartment leased to the manager.



Posted in Banking & Finance, Commercial Property, Leases & Leasehold, Property Law, Residential property | Tagged , , , | Leave a comment

Reducing Depreciation Recovery

When the property cycle starts to look like it is peaking, the temptation to sell comes calling… it may be worth thinking about all the depreciation claimed on your investment property.  Does it all have to be repaid if the property is sold for more than you purchased it?  Not necessarily.

This post comes courtesy of Ross Barnett at Coombe Smith Chartered Accountants in Hamilton.  Ross is a specialist in investment property tax matters, owns investment properties himself, and is active helping others on boards such as Property Talk forums. You can contact Ross at or by phone on (07) 839 2801.

Without further ado…


Quite a few property investors are thinking about selling, so I thought it was very timely to send through this article written  on reducing depreciation recovery.

Should you just accept that you will have to recover all the building depreciation you have previously claimed? ……… NO

In many cases, the building depreciation recovered is only a fraction of the total claimed and there are a number of ways to minimise it.

What is Depreciation Recovery?

In the past, property investors have been able to claim Building Depreciation.  An investor may have purchased an investment property for $350,000 of which $200,000 is land, $125,000 is building and $25,000 is chattels like carpets and curtains that have been valued by a Valuit Chattels valuation.  Most investors would have claimed 3% or 4% diminishing value depreciation on the $125,000 (or around $3,500 to $5,000) per year.  They also would have depreciated the chattels at their respective depreciation rates.  So over 5 years the investor may have claimed $20,000 of building depreciation, bringing the book value of the building down to $105,000.

In the past, the IRD has given a deduction for the reduction in value of the building.  If the building hasn’t been reducing in value, has increased in value, or has reduced at a lesser rate, then the property investor has been over-claiming building depreciation.  They have been claiming a deduction which is perfectly legal and allowable, but that isn’t really occurring in their circumstances.

When the building is sold, an investor who has been over-claiming this deduction, will then have to pay all or a part of it back again, which is depreciation recovery.

  • Depreciation Recovery generally only applies to buildings.
  • Chattels generally reduce in value at similar levels to IRD rates.  Therefore, when the investment property is sold, there is no recovery.  A chattels valuation could be obtained at date of sale to prove this.

Carrying on using the example given above, if the investment property is now sold 5 years later for $500,000.  The chattels might be worth $10,000, the building $190,000 and the land $300,000.  The building book value is only $105,000, so the $20,000 building depreciation claimed over the 5 years will be recovered and become taxable income.  From $125,000 to $190,000 is a $65,000 capital gain, which is currently non taxable in New Zealand.  In this example, the difference between the real building value $190,000 and the book value $105,000 is large, so there would be full depreciation recovery with no chance of reducing.  If the values are a lot closer, then there are a number of opportunities to reduce this.

How to reduce Building Depreciation Recovery?

1) Make sure your accountant or the person calculating the recovery knows what they are doing.  I have recently seen an example where an accountancy firm showed a recovery of $16,700 approximately when the recovered amount should have been $5,600 maximum.  This is a difference of $11,100 taxable income, or at the 33% tax rate $3,663 extra tax paid for no reason. This is a great reason to use a real ‘property accountant’, someone who specialises in and understands property.

2) A starting point to establishing the building value is normally the rates valuation.  From the rates information, work out what percentage is building and then apply this to the sale figure (less deductions!).  If this figure is over your building book value, then there will be building depreciation recovery (presuming you have claimed building depreciation in the past).

3) If the rates figure and the book value are similar, you could look at writing a clause in the contract.  The parties agree the building value is $XXXXX.

  •  Example – The building cost $125,000 and closing book value is now $105,000 so $20,000 building depreciation claimed.  The sale value is $300,000 and based on the rates valuation the building should be worth $112,500.  The parties could write a clause in the contract, “The parties agree that the building value is $105,000”.  As long as the two parties are not related, then this is the sale price.
  • You should not be too aggressive with this approach and the building value needs to be reasonable.

4) Any legal fees for the sale will be claimable under the new legal fees deduction rules.

5) Any commission or other costs incurred for the sale need to be deducted from the sale price, before the building value is calculated.

6) If you are confident the building value is close to the closing book value, then you could obtain a registered valuation to prove this.  We frequently do this for clients, as the rating valuations are not always realistic or are out of date.  Recently a client saved over $20,000 in depreciation recovery, or over $7,000 in tax at the 33% tax rate, just by obtaining two valuations for less than a cost of $500.

Overall, don’t just accept a depreciation recovery.  Think it over, ( “Has my gain come through land or building?” and “Has my building really decreased slightly in value?”), justifying any previous depreciation claims, and meaning there should be little or no depreciation recovery.

Kind regards
Ross Barnett
Branch Manager
Coombe Smith Chartered Accountants
Hamilton Branch

Normal Office Hours: Monday – Friday, 8am – 4pm

Phone: (07) 839 2801
Fax: (07) 839 2802
Level 1, 851 Victoria St,
PO Box 9317, Hamilton

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