Deductibility of holding costs for land
On 31 March 2023, Inland Revenue released a draft interpretation statement (PUB00417) addressing the deductibility of land holding costs - namely, interest, rates and insurance - and the relevance of whether the land is taxed on disposal. This had been an area of uncertainty since the introduction of the residential bright-line provisions in 2015, which can result in a disposal of land being taxable even if it was held on capital account or used privately.
Inland Revenue previously released a consultation document in October 2019, which considered three options in relation to a taxable disposal of land, where the land had been used wholly for private purposes (for example, a holiday home subject to the bright-line test):
1. Apportion the holding costs between the taxable gain and private use of the land.
2. Allow deductions for all holding costs, despite private use.
3. Deny deductions for all holding costs for periods of private use.
While Inland Revenue conceded that apportionment would provide the most accuracy, they concluded that due to complexity, the preferred option was to deny deductions for holding costs for periods of private use.
Inland Revenue’s view on this issue remains unchanged from the initial 2019 consultation document. The draft interpretation statement reaffirms that land held on capital account will not give rise to deductible holding costs, even if the disposal is taxable. It was emphasised that there must be a sufficient nexus between the expenditure and the derivation of income from the taxpayer’s income-earning process, and that taxpayers must look at what the land was used for in the period that the expenditure is incurred. Consequently, holding costs will only be treated as deductible to the extent that there is income-earning use of the land. It is further noted that income-earning use can comprise holding the land for the purpose of resale or deriving rental income, but specifically excludes holding the land on capital account, even if it is taxable under the bright-line provisions.
The statement also clarifies that if there is both private use and income-earning use of the land, then holding costs will need to be apportioned. In the first instance, attention should be given to whether the mixed-use asset regime applies, in which case specific rules must be followed. Otherwise, general principles should apply, such as a time-based or space-based apportionment. To complicate things further, the interest limitation rules, and the residential ring-fencing rules may also need to be considered.
Given the increasing scrutiny and tightening of legislation on residential property in recent years, Inland Revenue’s stance is somewhat unsurprising. However, for those who feel strongly on this topic, consultations are open until 31 May 2023.