Treatment of land holding costs explained by Inland Revenue

By Robyn Walker

The introduction of, and extension of, the bright-line test has led to more taxpayers having to consider whether they are entitled to deductions in relation to land. 

Before getting excited that the answers to all your tax questions concerning land will be answered within these 52 pages, the paper actually has a very limited scope despite its extreme length. The paper focuses on whether interest, rates and insurance (collectively referred to as ‘holding costs’) incurred whilst land is owned is deductible, and then considers whether it makes any difference if the property is taxable (e.g. under the bright-line test) if it is sold. The analysis does not apply to companies. The guidance does not explain how the land sale rules (including the bright-line test) work; nor does it explain how to determine the cost of land if it is sold or how taxpayers deal with a lump sum of income. For all that it doesn’t cover, it remains a mystery to the author how this topic filled 52 pages.

Despite its controversial length, the conclusions reached in the draft guidance are not themselves particularly controversial and Inland Revenue doesn’t think it represents a new or different approach to what Inland Revenue has historically taken.

So, to summarise the main conclusions in less than 52 pages:

• If you hold land on capital account and only use it privately, if you end up taxed under the bright-line test you are not able to claim a deduction for any holding costs.
• If you hold land on capital account and use it for deriving income (i.e. you rent the property), your holding costs will be deductible as they are incurred, subject to the application of the interest limitation and ring-fencing rules. Deductions will also need to be apportioned in a reasonable manner if the land has a mixture of business/private use. If you end up taxed under the bright-line test, you may be able to deduct holding costs that had previously been blocked through the interest limitation or ring-fencing rules.
• If you hold land on revenue account (i.e. you acquired it with the intention of resale), holding costs will be deductible as they are incurred (subject again to the interest limitation rules). If the taxpayer has notified the Commissioner that the property is held on revenue account, ring-fencing rules do not apply. The extent of deductibility of holding costs will depend on whether the property is also used privately. If there is private use of the land, then the mixed-use asset rules may apply, or otherwise, a reasonable apportionment is required. Inland Revenue indicates that where property is held on revenue account and there is a dual use of the land (i.e. it is held for resale whilst simultaneously it is used privately) then a starting position should be that 50% of holding costs are deductible.
• Holding costs do not form part of the cost price of land. Any capital improvements may form part of the cost (this is not elaborated on in the statement).

What is becoming increasingly clear is that all the tax rules related to land are becoming increasingly complex and the guidance increasingly long. It is necessary for land-owners to consider a wide range of tax regimes and rules including:

• Bright-line tests, land sale rules, and associated roll-over rules
• Residential ring-fencing rules
• Mixed-use asset rules
• Interest limitation rules
• Deductibility of healthy homes expenditure
• GST zero-rating rules, apportionment rules and marketplace rules which apply from 2024.

Given the amounts involved when dealing with land can be significant, we recommend seeking professional guidance. Please reach out to your usual Deloitte advisor for more information.

April 2023 - Tax Alerts