Tax deductible heat pumps

Taxation impacts of the Healthy Homes Standards

Taxation impacts of the Healthy Homes Standards

We received this article from an accounting business in Manukau and thought there was some quite interesting information regarding taxation and heat pump systems.

Introduction

The introduction of the Healthy Homes Standards (HHS) could cost landlords that are non-compliant a lot of money as all rental properties are required to be brought up to new standards. The ‘silver lining’ (if it can be called that), is that the Government have recently made a series of tax changes in response to the COVID-19 virus. One change around asset expensing thresholds may provide considerable tax benefits to landlords.

Background

By now you are likely to be familiar with the HHS requirements. If not, basically HHS’s are specific minimum standards for heating, insulation, ventilation, moisture ingress/drainage and draught stopping in rental properties. They were introduced in July 2019.

  • For some rental properties, a bit of maintenance or low-value spending will bring them in-line with the standards e.g. replacing some window seals to minimise drafts. Such minimal work and spending are generally tax-deductible. This means expenditure is offset against rental income immediately (reducing profit).

For others, there is the potential for major capital expenditure.

  • Capital Expenditure is not tax-deductible. This means the cost will not be offset against income (i.e. no direct effect on profit).
  • However, it may be partly tax-deductible if it is an asset that is depreciable. In this case, the cost is written off over the estimated life of the asset-based on IRD depreciation rates.

Tax rules – Tax Deductible vs Capital Expenditure

At a high level, expenses are tax-deductible when they are incurred in earning taxable income. However, there is an exception when the expenditure is improving an asset and where it’s over a certain value. Simple examples of this include adding something to a property that wasn’t there beforehand or improving a property beyond its original state.

In summary:

  • Expenditure on assets or improving an asset is generally not tax-deductible.

However, there is an exception for low-value assets/levels of spending. These are detailed below:

  • Up until 17th March 2020, capital improvements or assets are tax-deductible if the cost is under $500. Any low-value assets under the threshold provide an immediate tax write off benefit.
  • From 17th March 2020, there is a 12-month temporary increase in the threshold to $5,000. The thought behind this is to encourage businesses to spend. After 12 months the threshold will revert to $1,000 (a $500 increase on the pre-17 March 2020 threshold).

Based on the changes above, there is new scope to time upgrades to rental properties in order to maximise tax deduction opportunities whilst complying with the new compulsory standards thatall landlords must comply with. It could make good sense to spend money getting your property compliant while the temporary asset threshold of $5,000 is in place.

Examples

Scenario one: Heat Pump Installation before 17th March 2020

Jill’s rental property has heating capacity below the HHS minimum standard. She decides she will make her property compliant soon after the HHS introduction date (July 2019). In August 2019, her local heat pump installer installs a heat pump at a cost of $4,200.

Tax treatment

The $4,200 is not tax-deductible. It is an improvement to the property and is over the asset threshold in place at the time. Because it is over the $500 threshold, the heat pump is treated as an asset and depreciated over time (as opposed to immediately being tax-deductible).

Scenario two: Heat Pump Installation after 17th March 2020 (but before TBA)

Jack lives next door to Jill. Over a Christmas drink, Jill explains the HHS rules to Jack. Jack books in the local heat pump installer to install the same heat pump (costing $4,200) in January 2020. Because of the summer rush, the job isn’t completed by the installer until 20th March 2020.

Tax treatment

The $4,200 is tax-deductible.
• Even though it is an improvement to the property, it is under the temporary $5,000 asset threshold limit (introduced from 17 March 2020).

Jack’s late action on this occasion has worked in his favour!

Scenario three: Buying multiple Heat Pumps

Quite happy that he timed his previous heat pump purchase right and got full deductibility, Jack decided to install two heat pumps in his second investment property given it was split level. In May 2020 he contacts his previous installer who completes the work for $3,900 per unit – a total price of $7,800.

Tax treatment

This is not tax-deductible. Although each heat pump is under the low-value asset amount of $5,000 the total cost of both units is over the $5,000 threshold. Therefore, it is treated as an asset for tax purposes. It is therefore depreciated and written off over time (as opposed to getting an immediate tax deduction of $7,800). Note, if Jack had organised these as two different transactions, he would have got total deductibility as each transaction would have been under the $5,000 threshold.

Scenario four: Insulation top-up
Jill also decides to assess the insulation in her rental property. Most of the house’s insulation is compliant (thanks to the previous owner’s upgrade). There is one section that has had a bit of damage due to a water leak. Her handyman remedies the damage with insulation that has the same specs as the existing insulation. He sends a bill for $600 in September 2019.

Tax treatment

While Jill’s cost is $600 (and over the $500 asset threshold at the time), this is tax-deductible. The reason being is that:

  • Jill is remedying damage to part of the existing insulation i.e. a partial replacement as opposed to adding new insulation for the whole house.
  • As the replacement insulation is the exact same specs as the previous insulation, it’s replacing ‘like for like’ and therefore not an upgrade.
  • If the insulation she purchased was a higher spec this wouldn’t be a replacement with ‘like for like’ materials. In that instance, it would be classed as capital expenditure and added to the cost of the building. It would not be tax-deductible.

Scenario five: Insulation addition

Jack also decides to assess the insulation in his rental property. The insulation the previous owner had installed is under the required spec’s as the wrong product was used. In April 2020, he asks an installer to install new insulation at a cost of $6,000.

Tax treatment: This is not tax-deductible. Even though it is a replacement of the existing insulation, it is replaced with a better product. It is not considered ‘like for like’ and therefore the cost is added to the cost of the building (asset).

Finally

This is general advice only. Often all is not ‘black and white’ in the world of taxation, so we always suggest contacting your client manager prior to undertaking any major project.

If there is anything you want to discuss specifically, our phone lines are open as usual during normal business hours.

Should you wish to discuss your accounting requirements, we also have online meeting capability – all you need is a camera on your computer or cell phone to do this.

Stay safe.

Brendan Price, CA & Rachel Darlington, CA
And the Team @ Business Like NZ Ltd

09 262 0726
info@blnz.co.nz
www.businesslike.co.nz
https://www.facebook.com/businesslikenz

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