IS 23/10 released by IRD considers the deductibility of holding costs and whether land being taxed on sale is relevant to deductibility.
What are holding costs?
Holding costs are the expenses related to and associated with owning land. Examples include interest, insurance, rates, any repairs, or maintenance. Holding costs do not include capital improvements.
For holding costs to be deductible, there must be sufficient connection between the expense and the derivation of income. In order to determine whether a sufficient connection exists, you will need to consider whether the property is being used for income earing uses.
Income earning use of the property include renting it out and earning revenue. Holding property on capital account is not an income earning use even if the sale of the property is captured under bright line and taxed. This is because the deductibility test looks at the taxpayers intentions regarding the expenditure at the time it was incurred.
However, IRD does accept that holding costs for land are deductible from the time that there is a binding contract to sell the land, if the sale will be taxed. If the property is used for earning income other rules affecting the deductible amount include:
- deductions are not allowed to the extent the expense is a private expense (for example, if you or family or friends use the property); and
- interest deductions for residential properties may be denied either fully or in part under the interest limitation rules.
If your allowable deductions for the property (or a portfolio of properties you own) are more than the income from the property (or portfolio), the ring-fencing rules may apply to limit the amount you can deduct that year. If the amount you can deduct is limited under the ring-fencing rules, the excess is carried forward and may be used in a future year.
If some or all of your interest is non-deductible only because of the interest limitation rules, it will become deductible if the sale of the property is taxed. The ring-fencing rules may still apply to limit the amount of the deduction you can claim that year.
On Revenue Account
If the property is held on revenue account and you do not use it privately, the holding costs are fully deductible except for any interest that’s disallowed under the interest limitation rules. The deduction for deductible holding costs will be claimed in the year the expenses are incurred, subject to ring fencing rules.
If the property is held on revenue account and you are also using it for private use, holding costs will be partially deductible to the extent that they were incurred for income earning use. To do this you will ned to work out your total holding costs and apportion these between private and income earning use. IRD accepts a 50% deduction for periods of private use. For periods when the property is not being used privately, holding costs will be fully deductible.
When you have sold the property, any interest you can’t deduct while you own the property becomes deductible in the year of the taxable sale of the property, this is because of interest limitation rules.
On Capital Account
If you hold the property on capital account and use it to earn income with no private use, holding costs will be fully deductible for the income earing periods, except disallowed interest under interest limitation rules. Holding costs are not deductible for any non-income earning period.
If the sale of the property is taxed, any interest that you can’t deduct while you own the property, becomes deductible if the sale of the property is taxed.
If the sale is taxed under the bright-line test, the interest previously disallowed only because of the interest limitation rules gets added to the cost of the property, which you can deduct from the sale proceeds. However, if your bright-line sale is loss-making, you may not be able to claim the full cost deduction that year. Any excess cost deduction you can’t claim that year gets carried forward and you may be able to use it in a future year if you derive income from another property sale.
If the sale is taxed under a rule other than the bright-line test, the ring-fencing rules may apply to limit the amount of the deduction you can claim that year.
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