Are repairs to your flood-damaged property tax deductible?
Northern New Zealand has seen an absolute deluge recently which has caused terrible damage to roads, houses and even caused deaths. While people begin the clean up, those who use their property to earn a rental income might be wondering, “are the repairs to my flood damaged property tax deductible?”
As is often the case with tax law, the answer is “it depends”. Generally, if you replace an item like for like then the repair is likely to be tax deductible and called “Repairs and Maintenance”. If the damage is considerable and leads to significant repairs it may no longer be deemed repairs and maintenance and instead deemed to be capital expenditure.
When determining if expenditure is repairs and maintenance and therefore deductible or capital in nature and depreciable there is a two step approach:
- Determine what the asset is
- Decide if there has been a “like for like” replacement or an improvement.
Determining the asset
In the case of a home we need to consider which parts are assets on their own and which make up part of the building. This can be complicated and can depend on whether you’ve separately identified parts of the house when it was purchased or if you have listed the whole purchase price as “land and buildings”.
Assets that can’t easily be detached from the building like framing, gib board, skirtings etc. are not assets in their own right. Instead they make up part of an asset – the house.
Things that may be an asset in their own right are things like curtains, carpet, appliances etc. These items are more easily removed from the house and have a value by themselves. How you treat these assets may depend on how you have treated them previously – it is best to get some advice around this.
A like for like replacement or improvement?
Once we know what the asset is the next step is to decide whether the asset has been improved or repaired. With the same examples as above, where framing timber and gib board has been damaged by flooding, the replacement of this would be considered repairs and maintenance. That is because the asset is the house, not the building materials. The house has been repaired with “like for like” materials and has not been improved.
If you decide to use the flood damage as a reason to move some walls in the house and build an extra bedroom then this expenditure will be capital. Because you are no longer replacing like for like but actually improving the property it will not fit into the category of repairs and maintenance. Depreciation on residential buildings is 0% so this expenditure is essentially black-hole expenditure.
If curtains and carpet are damaged then the replacement of these items may be capital or repairs and maintenance, depending on whether those items had been separately identified on your depreciation schedule previously. If so, these will need to be added to the fixed asset schedule and depreciated over time. You will be entitled to a deduction for the book value of the original carpet and curtains when they are written off from your depreciation schedule.
If you have not separately listed curtains and carpet on your depreciation schedule then you may argue that the asset in question is the house which includes the carpet and curtains. Any like for like replacement may be repairs and maintenance.
Since March 2020, assets with a purchase price of $1,000 or less can be deducted in the year they are purchased and do not have to be added to the asset schedule.
Let’s walk through some examples
Alex owns a rental property on Auckland’s North Shore which flooded in the recent storm. The flood caused the lino on the floor of his kitchen to peel up and the water soaked into the chipboard flooring beneath it. If Alex replaces the chipboard flooring and lino with new chipboard flooring and lino then this expense will be deductible.
If Alex decides he’d prefer some laminate wood flooring planks instead of lino then the replacement of the chipboard would be deductible as it is like for like but the replacement of the lino with laminate would be considered an improvement. This is because laminate flooring is a superior product to lino. The laminate flooring would be capitalised and depreciated at the appropriate depreciation rate from the IRD.
If Alex’s home is declared completely uninhabitable and needs to be knocked down and rebuilt then this is not repairs and maintenance. Because the work is extensive, this would be considered capital and need to be added to the fixed asset schedule. The original home and chattels would be written off.
Insurance Proceeds
Another thing to keep in mind is that your insurance proceeds may be taxable income. If you receive an insurance pay-out to pay for some or all of the repairs and those repairs are deductible, then the insurance pay-out is taxable income. If the insurance pay-out was used instead for capital expenditure, then the amount received from your insurance company will be non-taxable income.
As is likely to be the case, a property which suffers flood damage will have a mixture of both deductible repairs and maintenance and non-deductible capital expenditure. If you are unsure about the deductibility of the repairs to your property or how to treat your insurance proceeds, get in touch with us to help.