Renovating a Rental? Capital vs Revenue Expenditure

This week (31 January 2024) Inland Revenue released a Technical Decision Summary regarding renovation work completed on recently acquired properties.  The taxpayer was a trust and purchased several rental properties.  All but one of those properties were tenanted at the time of purchase.  The taxpayer then undertook work on the properties, including replacing kitchen units, adding dishwashers and heat pumps, replacing bathroom fittings, replacing carpets/vinyl, repairing and repainting exterior and interior walls, and cleaning and repairing roofs. 

The taxpayer’s position was that at the time of purchase the properties were fit for purpose and the work completed was to bring them back to their original condition and no improvements were made to the properties.  Based on this, the taxpayer claimed a full deduction for the costs in its income tax return.  The taxpayer did later make a voluntary disclosure to treat some amounts as capital expenditure and therefore the deduction was reduced.  A voluntary disclosure is a legal process that allows taxpayers to declare past errors or omissions and a valid voluntary disclosure can lead to a reduction in shortfall penalties that the Commissioner may seek to impose.

Inland Revenue considered that the amount paid for the work on the properties was capital for two reasons:

1. The renovation expenditure was part of the cost of acquisition for the properties; and

2. The work went beyond ordinary repairs and maintenance.

The Tax Counsel (TCO) determined that the expenditure relating to the work undertaken by the taxpayer was not deductible at all, but rather, it was a capital cost of acquisition of the properties.  The TCO found that the cause of the need of the work was to remedy inherited legacies of disrepair from the vendors’ use of the properties. 

It has long been the case that repairs to “dilapidated buildings” are non-deductible and should be treated as capital expenditure.  This recent case should heed as a reminder that when purchasing run-down properties and repairing them, the expenses are likely to be capital expenditure rather than deductible.  You can read more about deductibility of property related expenditure in this article.

This article is intended for informational purposes only and should not replace specific tax advice.  If you have any questions or concerns about the distinction between capital and revenue expenditure issues, please contact us.

This article was accurate at the time of publishing.