Tax Updates: 14 April 2025

Welcome to this week’s review of tax issues where Richard comments on what’s been happening in the world of tax over the past week. If you have a question or would like a second opinion on any national or international tax issues, please contact Richard via email at richard@gilshep.co.nz.

Residential property – which tax rules do I use?

Those of you who prepare financial statements and income tax returns for residential properties will no doubt appreciate the annual decision you have to make as to which set of income tax deduction rules apply to the property – the mixed-use asset rules or the standard tax rules. And then, if the latter, whether the residential property ring-fencing rules may also apply. And then what happens to the quarantined expenditure you may have under either set of rules if you change from one rule set to the other?

To assist with determining which set of rules should be applied in a particular income year, and then the consequences of changing from one rule set to another, Inland Revenue (IR) has issued IS 25/08 – Income tax – implications of a residential property moving between the standard tax rules and the mixed-use asset rules.

The interpretation statement (IS) is a 35-page read, which provides commentary on four topics:

• which income tax deduction rules apply to the residential property when its use has changed from the prior income year;

• the effect of a change in income tax deduction rules on a person’s ability to use prior year quarantined expenditure under the mixed-use asset rules;

• the effect of a change in income tax deduction rules on a person’s ability to claim prior year unused excess deductions under the residential property ring-fencing rules; and,

• how the depreciation rules apply to depreciable property used in a residential property when there has been a change in which set of income tax deduction rules apply to the property.

If, during a particular income tax year, the residential property has been partly used to earn income, partly used for private use, and it was unused for at least 62 days, then the property will be subject to the mixed-use asset rules for that income year (subject to any available exclusions). However, if either the property was not used privately or it was not unused for more than 62 days, then the standard tax rules will apply to determine the deductions that can be claimed for the income year.

Having applied either set of rules for an income year, you may find that you either have quarantined expenditure under the mixed-use asset rules or excess deductions under the residential property ring-fencing rules. Both of these amounts can be carried forward to the next income year, which is available to offset future income derived from the residential property. An important point to note here, however, which IS 25/08 comments on, is that quarantined expenditure can only be utilised when the mixed-use asset rules are in play and vice versa with respect to the excess deductions arising under the residential property ring-fencing rules. In other words, if you had applied the standard tax rules in the previous income year, which had resulted in excess deductions carried forward to the current income year, should the residential property be subject instead to the mixed-use asset rules in the current income year, then those excess deductions cannot be used in the current income year. However, you will be able to carry them forward to the next income year.

In relation to deprecation deductions, calculate your depreciation loss for each item of depreciable property as usual, and then determine which set of rules you are applying for that particular income year. If the mixed-use asset rules apply, then the apportionment formula in section DG 9 will determine your depreciation deduction for the year. Otherwise, under the standard tax rules, you’ll simply apportion your claim if the property was not used wholly to derive income for the year.

IS 25/08 is full of examples to illustrate the commentary. You may want to take some time to explore and fully understand how depreciation deductions are calculated from year to year under both sets of rules. But equally, you may also want to explore what happens when the asset is disposed of, both from the perspective of how to calculate the deprecation recovery income, and what happens to any remaining excess deductions or quarantined expenditure, which contains a component of depreciation loss.

This article was originally published through the ‘A Week In Review’ newsletter. If you would like to receive Richard’s tax updates every Monday morning, you can subscribe here.