Bye-bye building depreciation – the consequences

By Joe Sothcott, Iain Bradley & Denise Hodgkins

The Taxation (Annual Rates for 2023-24, Multinational Tax, and Remedial Matters) Act 2024 included the Government’s headline tax policy changes, including the removal of commercial building depreciation from the 2024-25 income year onwards.

We highlighted this coming change last year to help taxpayers prepare for the change. But withnthe technical details only now revealed as the policy is enacted, it is time for a deep dive into what it all means and how commercial building owners might be affected.

The big picture

Before 2010, commercial buildings were depreciable for tax purposes. This was first removed by the then National government, before being restored under the Labour government in 2020 as part of the response to the COVID pandemic. When commercial building depreciation was restored, the change was said to be permanent. But, as we all too often know when it comes to taxes, nothing is a certainty and both major political parties campaigned on removing commercial building depreciation to pay for other tax policies.

The change is significant. Inland Revenue estimates it will bring in $2.31 billion of additional tax over the forecast period (2024/25 – 2027/28). On the flip side, the change may prove to be quite expensive for taxpayers who own commercial buildings, not only in the lost depreciation but also the compliance costs incurred in dealing with this change.

The details

From 1 April 2024 (for standard balance date taxpayers), commercial building depreciation deductions can no longer be claimed. Technically buildings will still be considered “depreciable property”, but the annual depreciation rate will be set at 0% so no deduction will be available. The purpose of setting the rate at 0%, rather than having buildings be non-depreciable property altogether, is to ensure the property remains subject to the depreciation rules, such as depreciation recovery income if it is sold for more than tax book value.

The change affects all commercial buildings with an estimated useful life of 50 years or more. Taxpayers should take some time to understand what this means. An estimated useful life of the building is determined on a whole-of life approach, rather than a remaining life basis. This means that consideration will need to be given to the estimated useful life of the building based on the materials the building is constructed of (most concrete, steel or timber buildings have an estimated useful life of 50 years, while some agricultural or industrial buildings have a shorter life). Taxpayers should refer to Inland Revenue’s depreciation rates to determine the correct estimated useful life for a particular type of building.

In terms of other changes, the legislation clarifies that a building includes where parts of a building have been separated into unit titles. Additionally, the definition of a building has also been amended to exclude commercial fit-out.

The fit-out rules

When building depreciation was first removed in 2010, section DB 65 was added to the Income Tax Act 2007 to allow taxpayers to separate an amount that covered the cost of commercial fit-out from the building’s adjusted tax value. This was required as previously some taxpayers had been content to not separately itemise fitout from the cost of the building and depreciate it as part of the building.

Section DB 65 deemed 15% of the building’s tax book value at the end of the 2010-11 income year to be attributable to fit-out. Depreciation could be claimed on the deemed fit-out component at 2%.

Jumping back to 2024, the new legislation effectively reintroduces this rule under new section DB 65B. This new rule only applies to those buildings owned before the 2011-12 income year where the fit-out was not being depreciated separately (other than under section DB\ 65), and reinstates the ability to claim deductions, albeit at the lower rate of 1.5%. Section DB 65B contains some prescriptive calculations that are required to ensure that the correct amount of deduction is claimed and is also designed to ensure that amounts claimed are factored into any disposal adjustments if the property is sold. 

If any taxpayers acquired buildings between the 2020-21 and 2023-24 income years when building depreciation was restored and still did not elect to split  out the fit-out, section DB 65B will not provide any assistance. Inland Revenue advises that those taxpayers can apply under section 113 of the Tax Administration Act 1994 (“a section 113 request”) to have the Commissioner of Inland Revenue exercise his discretion to amend previous tax assessments so they can separately depreciate fit-out acquired with a building. 

Deferred tax and tax expense implications

Taxpayers should also consider the deferred tax and tax expense implications of the removal of tax depreciation on commercial buildings in relation to any IFRS financial statements they are preparing.  Broadly, we would expect the deferred tax and tax expense impact should generally be 28% of the tax base of the commercial building at the end of the 2023/24 income year – however, this will be complicated by the fit-out rules discussed above and the application of the initial recognition exception, to the extent that either are applicable. The amounts involved may well be material.

If you would like assistance calculating the deferred tax implications of the removal of tax depreciation on commercial buildings, then please reach out to your usual Deloitte adviser who can liaise with one of our specialists in this area.

What do we think?

Deloitte does not support the removal of depreciation from commercial buildings. Several studies have concluded that buildings do depreciate. We think building depreciation is just like any other business expense and should be treated as such.

Deloitte is not alone in this. Inland Revenue also recommended building depreciation be retained and has suggested it be reintroduced when fiscal conditions improve. It also informed the Government that it believes the changes will be a barrier to attracting international investment.

Please get in touch with your usual Deloitte adviser if you have any questions.