When does a smoke alarm stop being a smoke alarm?
Tax Alert - August 2020
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By Robyn Walker and Blake Hawes
Everyone knows what a smoke alarm is; what its function and purpose is, and that most smoke alarms are battery powered, attached to the ceiling by a couple of screws and last about 10 years. However, some may be surprised to know that from a tax perspective when a smoke alarm is installed in a residential rental property it loses its identity and becomes part of a non-depreciable building.
The rationale for this treatment is set out in the recently released Questions We’ve Been Asked QB 20/01 “Can owners of existing residential rental properties claim deductions for costs incurred to meet Healthy Homes standards?” (“the QWBA”).
The crux of the QWBA is that if something is required by regulation to be included in a residential rental property, then that item forms part of the building and it loses its own separate identity. This occurs under step two of a three-step test:
Step 1: Determine whether the item is in some way attached or connected to the building. If so, go to step 2. If not, the item will be a separate asset.
Step 2: Determine whether the item is an integral part of the residential rental property such that a residential rental property would be considered incomplete or unable to function without the item. If so, the item will be part of the residential rental building. If not, go to step 3.
Step 3: Determine whether the item is built-in or attached or connected to the building in such a way that it is part of the “fabric” of the building. If so, the item will be part of the residential rental building. If not, the item will be a separate asset.
Smoke alarms are a compulsory item under the Residential Tenancies (Smoke Alarms and Insulation) Regulations 2016 (“the Smoke Alarm Standard”). Therefore, while a building can certainly provide shelter and function as a building without a smoke alarm, it would however be “incomplete” under the Smoke Alarm Standard. The outcome of step two is that it is not necessary to look at step 3. The installation of a smoke alarm can neither be expensed as a low value asset nor capitalised and depreciated as a separate asset (despite a depreciation rate existing for smoke alarms in the residential rental asset category).
With the upcoming expansion of requirements on landlords under the Residential Tenancies (Healthy Homes Standards) Regulations 2019 (“the HHS”), the analysis applying to smoke alarms will also start applying to other functionally separate assets once the HHS come into effect. This aspect is not articulated as clearly as it could be in the QWBA, as someone only reading the conclusion and not the full detail of the QWBA may rely on a statement that some heat pumps are separately depreciable assets. The QWBA has this to say about heat pumps: “The Commissioner considers that heat pumps and the other forms of heating sufficient to meet the 2019 regulations are not yet a required feature of all residential rental buildings. Accordingly, at present, a building may be considered complete without these particular heating systems. As such, they are not integral to the building under step 2.” The key words are “not yet a required feature”. Once the HHS heating standard is in place (which may be as early as 1 July 2021 depending on when tenancies change, or 1 July 2024 at the latest), any new heat pumps will become an integral part of the building and will no longer be treated as a separately depreciable asset.
The irony of the QWBA is that if a landlord complies with the HHS prior to them being in effect, then full and immediate deductions can be claimed for some of that expenditure (currently low value items costing less than $5,000 can be immediately expensed, with this amount moving to $1,000 from 17 March 2021). After the HHS take effect the analysis changes and the cost of acquiring any assets to comply with the standards then fails the three-step test and the costs are no longer deductible or depreciable as a separate asset, as they form part of a residential rental building (which is depreciable at 0%). The silver lining, if you can call it that, is that because the item becomes part of a larger building asset, if in the future it is necessary to replace the item (e.g. a heat pump) then that may be “repairs and maintenance” to the building which would be immediately deductible.
The QWBA essentially says if there is a legal requirement for assets to be used together, that those things are actually a single asset for tax purposes as a result of applying the three step test above. While the QWBA is limited in scope to residential rental properties, it is difficult to understand why there is a different outcome for commercial and industrial buildings, which are likely subject to much more extensive legal requirements; for example not just smoke alarms, but emergency warning systems, sprinkler systems, dry risers etc. These items would currently be separately depreciated in most instances. How or why the outcome should differ between building types is currently unclear.
For more advice on how to treat expenditure on residential rental properties contact your usual Deloitte advisor.
Other rules for property owners to be aware of:
Deductibility of low value assets
A business may claim an immediate deduction for any low value assets acquired provided that:
- All assets acquired from the same supplier on the same day with the same depreciation rate have a combined cost of $5,000 or less (until 16 March 2021) or $1,000 or less (from 17 March 2021);
- The item has not been and will not become part of any other property that is depreciable property (e.g. it is not part of a building).
Residential Rental Loss Ring Fencing
Loss ring fencing rules came into effect from the 2019/20 income year. These rules restrict the ability of property owners to claim deductions in excess of the income earned from residential rental properties. You can read more about these rules here.
August 2020 Tax Alert contents
- When does a smoke alarm stop being a smoke alarm?