Difference between residential and commercial properties
Residential properties are typically homes or apartments. These might be family houses, townhouses, studios, etc. Investors in residential property market rent out the properties on a long-term basis. This type of investment is exempt for GST purposes, which means you do not pay GST on rental income from long-term residential renting, nor claim GST on the long-term residential expenses.
Commercial property, on the other hand, is any property not primarily used as a residence, for example retail spaces, office spaces, commercial units such as warehouses etc. Investors in such properties usually lease them out to other businesses or they may run a business out of their own space. With Commercial properties, the related income and expenses are subject to GST, so investors need to manage their GST filing with Inland Revenue either by themselves or through their tax agencies.
Expenses you can claim
Property investors can claim deductions while properties are rented or available for rent.
Interest on borrowings
As of 1 April 2025, interest incurred on loans used to acquire residential investment property is 100% deductible, provided the general deductibility rules are met. This marks the end of the interest limitation rules that were phased in from 1 October 2021 and denied or limited deductions for residential property interest. For the period between 1 October 2021 and 31 March 2025, deductions were phased out for “grand parented” loans (drawn down before 27 March 2021) and denied entirely for new loans. The key principle for deductibility is tracing the use of the funds. Interest on a loan is deductible to the extent the borrowed funds are used for an income-earning purpose, such as purchasing the rental property.
Interest on loans to acquire commercial property is fully deductible, as it was never subject to the residential interest limitation rules.
Repairs and Maintenance vs. Capital Improvements
A clear distinction must be made between repairs, which are generally deductible on revenue account, and capital improvements, which are not.
Repairs and maintenance costs are related to work undertaken to restore an asset to its previous condition without changing its character. This remedies deterioration or replaces subsidiary parts of the whole asset.
Capital improvement results in the reconstruction of substantially the whole asset, changes the character of the asset, or provides a new and different advantage or function. The costs are added to the asset’s capital value.
Depreciation
Starting 1 April 2024 for most taxpayers, depreciation deductions can no longer be claimed for commercial and industrial buildings. This change was enacted by the Taxation Act 2024 and marks a return to the pre-2020 tax settings, which also disallowed building depreciation. Depreciation for non-residential buildings was temporarily reintroduced from the 2020–21 income year as a response to the COVID-19 pandemic, but this has now been reversed.
While depreciation deductions cannot be claimed on buildings either residential or commercial, for landlords of residential rentals, depreciation can be claimed for chattels owned by the landlord within the property. An immediate deduction can be claimed for low-value assets costing $1,000 or less.
For commercial buildings, depreciation can still be claimed on commercial fit-out items like air-conditioning systems, lifts, partitions, and plumbing. Therefore, it is crucial to separate the value of the fit-out from the building structure.
Other Common Deductible Expenses
The following expenses are generally deductible to the extent they relate to the derivation of rental/lease income:
- Rates and Insurance: Council rates and premiums for landlord and building insurance.
- Management Fees: Fees paid to property managers, letting agents, and commissions.
- Professional Fees:
- Accounting: Fees for the preparation of annual accounts and tax returns.
- Legal: Legal fees for arranging a mortgage are deductible. Legal fees incurred in buying an investment property are also deductible.
- Valuation Fees: Costs of obtaining a valuation required for mortgage purposes.
- Travel: Costs of travelling to inspect or maintain the property. A logbook or detailed records should be kept.
- Advertising: Costs of advertising for tenants.
Bright-line Test
The bright-line rule means that if you sell a residential property within a set period after acquiring it, you will be required to pay income tax on any profit you made through the property increasing in value. Properties that have been the owner’s main home for the entire time they owned it are exempt from the rule. The bright-line property rule does not apply to commercial properties.
The bright-line period has changed several times since its introduction. The applicable period depends on the date the property was acquired. For disposals occurring on or after 1 July 2024, a new two-year test applies regardless of the original acquisition date. This replaced the previous 10-year and 5-year tests.
Last but not least, investors should discuss with their accountants regarding the ownership structure for their investment during the due diligence process.
The comments in this article are of a general nature and should not be relied on for specific cases, where readers should seek professional advice. Don’t let valuable opportunities slip through the cracks. Contact Ingham Mora, your trusted Tauranga accountant, today to schedule a consultation and unlock the full potential of your property investment.
