Holding costs for privately used land that is taxable on sale – Should these be deductible?
Tax Alert - November 2019
By Emma Marr and Nicole Tan
Highlights from the IRD consultation document
In October 2019 Inland Revenue released a tax policy consultation document on Holding costs for privately used land that is taxable on sale. This outlines Inland Revenue’s view on the way in which the current rules work for deducting land holding costs, and proposes two legislative changes to make them work as intended.
There is currently a lack of clarity around the deductibility of holding costs (for example, rates, interest, insurance, and repairs and maintenance expenditure) for land that is subject to tax on sale, and is used privately before sale. Inland Revenue’s current view is that denying deductions for all holding costs for periods of private use would be the best option.
Further, if land is vacant for a period of time while it is held, but it is used for other periods of time, whether it is treated as being held privately or for income earning purposes will depend on what it is used for while it is not vacant (e.g. for a bach, whether it has been used privately or rented out for the periods it is not vacant).
Finally, the rules allowing deductions will need some tweaks to make them work properly.
Options for allowing costs to be deducted
The document considers three options for deciding what costs should be deductible. The first is to apportion the costs between the private use benefit, and the taxable gain on sale. The obvious problem is that it would be difficult to work out the value of the private use benefit, and, in Inland Revenue’s view, apportionment would be inconsistent with other areas of New Zealand tax law.
The second option is to allow all deductions. This would be a generous solution, and unsurprisingly Inland Revenue didn’t favour it, on the basis that this would allow deductions for private expenditure, which is inconsistent with an important principle of New Zealand’s tax framework.
The third (and Inland Revenue’s preferred) option is to deny all deductions for costs for periods when the land is used privately. Inland Revenue acknowledge this may seem unfair because it denies a deduction for costs that relate to earning a taxable profit. Nevertheless, Inland Revenue viewed this unfairness as more palatable than the problems with the other two options.
Consistency across different types of entities
The IRD consultation document focuses mainly on individual ownership, but acknowledges that different entities can hold land. The question arises as to whether the approach should be the same across different types of entities and what the impact would be on taxpayer incentives if the approach was inconsistent. On the basis that people should not decide which entity to use in owning land based on the tax rules, the Inland Revenue concludes that the rules should be the same for every entity.
Periods of private use vs vacancy
The document considers how to treat costs incurred on vacant land. Inland Revenue concludes that whether or not it is held for private or income earning purposes will depend on how it is used for the majority of the time. For example, if it is usually a rental but vacant for a couple of months, it can be treated as held for income earning purposes. If it is a bach but vacant half the year, it will be treated as held for private purposes. If it is vacant all the time, to be able to deduct holding costs it will need to have been acquired with the purpose of earning income, otherwise it will be considered to be held for private purposes.
Currently, the law is drafted so that the rule allowing costs for holding land to be deducted, is subject to two other rules:
- the general permission: this requires that for costs to be deductible they need to have a connection to earning income or carrying on business to derive income;
- the private limitation: this prevents deductions for costs that are of a private nature.
For land holding costs to be deductible where the land is held for private use, both of these provisions would have to be made subject to the rule that allows the deduction in the first place. The discussion document proposes a legislative change to make this happen.
If you would like to discuss the implications of these proposed changes please contact your usual Deloitte advisor.
November 2019 Tax Alert contents
· Deducting holding costs for privately used land that is taxable on sale