Business Accountants: New Legal Decision on Deductibility of Building Remediation Costs
The leaky building crisis has long posed a question of whether the remediation of such buildings qualifies as deductible repairs or non-deductible capital works. Historically, precedent cases have been outdated, often involving railway and gas pipe system remediations.
This ambiguity has persisted due to the financial strain leaky buildings impose on affected individuals, often leaving them unable to challenge the Inland Revenue Department (IRD). However, a recent ruling in the case of E & G Lawrence v CIR sheds some light on this issue, though it does not favor investors dealing with extensive remediations.
Case Summary: E & G Lawrence v CIR
In 2014, the Lawrences purchased a freestanding fibrolite-clad house in Tauranga for $350,000, with a government valuation of $305,000. A non-invasive visual inspection at the time deemed the house well-constructed and in good condition.
The Issues Begin
In 2017, leaks in the kitchen emerged due to internal guttering and poor roof design. Despite replacing the guttering, leaks persisted, prompting a redesign of the roof and guttering, and addressing issues like the lack of window flashings. The cladding, lacking a cavity, was also problematic. Consequently, the Lawrences undertook extensive works, including roof redesign, guttering, and recladding, which required consents.
Inspections during the consenting process uncovered non-compliant stud work, inadequate drainage, and a rotting deck needing replacement. A retaining wall also required redesign and rebuilding. These discoveries escalated the scope of the work.
Financial Claims and IRD Review
The Lawrences claimed $61,140 in 2018 and $303,654 in 2019 for the remediation work. A Code Compliance Certificate (CCC) was granted, and a 2018 bank valuation assessed the property at $700,000.
The IRD reviewed the claims, citing the capital limitation in section DA2(1), which denies deductions for capital works. While section DA 1(1) allowed for general deduction of expenses, as the property was consistently a rental, the dispute centered on whether the works were capital in nature.
Legal Proceedings
The Lawrences pursued a court remedy. The court considered precedent cases, focusing on:
- Whether the work resulted in the reconstruction, replacement, or renewal of substantially the whole asset.
- Whether the work changed the character of the asset.
- Whether the work formed a single project of work.
Court’s Decision
The court, favoring the IRD’s expert witness, concluded that the redesign of the roof, replacement of joinery and guttering, and recladding substantially reconstructed the house, altered its character, and extended its life. The judge ruled that these works were capital in nature and non-deductible, leading to a reassessment of the Lawrences’ tax returns and denial of the claimed deductions. Costs were awarded to the IRD.
Implications for Property Investors
This case reinforces the IRD’s stance on “extent and degree” arguments in remediation cases, making it more challenging for investors to claim extensive remediation as deductible repairs rather than capital works.
Acknowledgment
While the outcome is not favorable for investors, it is essential to recognize the Lawrences’ determination in pursuing this case. Their efforts have clarified the distinction between deductible repairs and non-deductible capital works, providing valuable insights for future cases.
For property investors, this decision underscores the importance of understanding the tax implications of remediation work and seeking expert advice when dealing with similar issues.
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