IRD has released a draft IS which covers the deductibility of holding costs for land and whether the land being taxed on sale has any influence on deductibility.
What are holding costs?
Holding costs refers to expenses incurred in the ownership of land. These include interest, rates and property insurance. The do not include the costs of capital improvements to the property or expenses related to the use of the property.
Connection between income earning and deductibility
In order for, holding costs to be deductible, there must be a sufficient connection between the holding costs and the derivation of income. This will be determined by the use or uses of the property and how it used in each income year.
Income earning uses of the property include renting it out and holding it on the revenue account. If the property is held on the capital account, it is not for income earning use even if the sale of property ends up being taxed. This is because to determine deductibility, you must look at what the taxpayer was seeking to gain from the expenditure at the time it was accrued. If the taxpayer had bought the property to keep on capital account, then they have not been incurring holding costs in order to derive an income.
Once it has been deemed that there is a connection between the holding costs and derivation of income, you must also consider the following limitations:
- Deductions are not allowed to the extent that the expense is a private expense e.g., if you or your family are using the property
- Interest deductions may be denied either fully or partially under the interest limitation rules. If some or all interest is non-deductible due to the interest limitation rules, it will become deductible if the sale of the property taxed.
- If allowable deductions are more than the income derived from the property (or multiple properties owned) the ring-fencing rules may apply to that income year to limit the deductible amount for that income year. Th excess may be carried forward and deducted in the following year.
When the property is held on the revenue account and there is no private use, holding costs are fully deductible. When there is some private use, the extent of the deduction will depend on the proportion of private use to income earning use. The expenses will need to be apportioned between private and income earning use. IRD allows a 50% deduction for periods of private use.
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