Land Holding Costs - second consultation document issued
Following closely on the heels of the recent consultation document issued to consider tinkering with the wording of the legislation contained in the ‘pattern of habitual buying & selling of land’ proviso, IR have issued another land-related consultative document, this time seeking public feedback on its proposal to clarify the rules surrounding the deductibility of holding costs (for example, rates, interest, insurance, and repairs and maintenance expenditure) where land that is subject to tax on sale is used privately while it is held.
IR proposes three potential options:
- apportioning the holding costs between the taxable gain on sale and the private use of the land while it is held;
- allowing deductions for all holding costs, even though there is private use; and,
- denying deductions for all holding costs for periods of private use.
Of the three options, the third is the preferred solution. Under this approach, you would take into account how the land has actually been used for any particular income year, to determine the deductibility of any holding costs for that particular income year. Where there is a mix of private and income earning use for the income year, then it is proposed that deductions would only be denied for the days where the land is actually used for private purposes.
Note that under this proposed option, for those of you with clients who like to regularly purchase properties for do-up, and live in the property while doing so, any holding costs incurred during the period of their occupation would be considered non-deductible.
The consultation document also briefly discusses the scope of the new rules, suggesting that they should apply consistently to individuals, partnerships, trusts and look-through companies. In the case of ordinary companies, private use of the asset by shareholders where the company is deriving no income from that use, usually dictates that most holding costs will not be deductible to the extent of that private use in any event.
Officials do acknowledge however, that with respect to interest costs, a company gets an automatic deduction with no nexus to income derivation required, which could therefore encourage taxpayers to use company structures simply to ensure 100% of their borrowing costs are tax deductible. The potential for abuse in this area, is tempered though by the fact that private use of a company asset by shareholders/employees where a market rent is not paid by the occupier in return, leads to deemed dividend consequences for the shareholders or taxable employment income/FBT exposures in respect of company employees. Officials propose to simply monitor this scenario, to determine eventually whether any legislative tinkering will be required to curb taxpayer behaviour.
Public feedback is also sought on the rule proposals targeting a popular pastime of some of our clients – land banking. Your client acquires a piece of land, often a vacant lot, and just sits on it for a period of time, perhaps commencing a minor subdivision within the requisite 10-year ownership period which then triggers a taxable disposal event. How should the deductibility rules apply to land that is not actively used for long periods of time – should the land be deemed to be a private asset or an income earning one?
Officials presently propose that the treatment of periods of vacancy as either private or income earning use should be based on the other uses of the land throughout the period of ownership. Arguably therefore, if your client was confident that they would never use the land in question for private purposes and that it will ultimately be put to an income earning use e.g. a rental property dwelling erected upon the land, then the holding costs incurred throughout the period of ownership should be fully deductible.
Finally it is proposed to make some amendments to section DB 23, to ensure that deductions in respect of revenue account land are not denied due to failure to satisfy the general permission at the time the expenditure was incurred or due to application of the private limitation. Both of these potential deduction limiting provisions will be overridden when a disposal of revenue account property occurs.
Submissions on the proposals close 1st November 2019 and the consultation document can be found here - http://taxpolicy.ird.govt.nz/sites/default/files/2019-ip-land-holding-costs.pdf