For most assets, it is straightforward to determine whether expenditure is deductible. If the asset is only used to derive income or used in business, related expenditure will generally be deductible.
If the asset is only used privately (such as a private house or a car) then no deduction is available for related expenditure.
Because mixed-use assets combine both private and income earning use in a single asset, questions arise about the appropriate portion of expenditure that will be deductible.
The easiest way to explain this is to divide expenditure into “daily amounts”. If a bach is used by its owners for 40 days in a year, and rented out for 25 days in that year, it is clear that:
- 40 days’ worth of expenditure is not deductible
- 25 days’ worth of expenditure is deductible.
What is not clear is what happens to the expenditure which relates to the 300 days of the year when the asset is not used at all.
Under the previous rules, the 300 days when the asset is “available for income-earning use”, also gave rise to deductions. This means the owner would claim deductions for expenditure relating to 325 days, or 89% (325/365) of total expenditure.
This was not considered an equitable outcome, given that the asset was used both for income earning and private purposes, and indeed, the principal purpose of acquisition may well have been private.
In order to address this issue Inland Revenue undertook an extensive review of the rules applying to mixed-use assets and new apportionment rules were introduced from the 2014 tax year for assets relating to the provision of short-term accommodation and the 2015 tax year for boats and aircraft (with a market value of more than $50,000 at acquisition)
For the purposes of these rules, the asset will include any assets which are related to it. For example a holiday home includes items such as the furniture and appliances and a yacht includes items such as the dinghy and lifejackets.
The new rules establish an apportionment method to determine the deductibility of expenditure associated with them. In this case the proportion of expenditure that is now deductible is calculated by dividing the number of days in which the asset was actually used to earn income by the total number of days the asset was actually used for both purposes.
In the illustration above, this would mean the owner would now be able to claim 38.5% of expenditure (25 days of income earning / 65 days of total use).
A number of other changes have also been made:
- Owners can opt out of the tax system if the asset has earned gross income of less than $4,000 in the tax year, this means no tax on the income however no deductions are allowed.
- when the income received from the business use of the asset is low (2% or less of the assets market value) any tax losses generated by the mixed-use asset cannot be offset against other income, but must be carried forward and offset against future profits generated by the same asset.
- in order to avoid an unfair advantage to taxpayers who choose to hold their mixed-use assets in a corporate structure the new rules apply to mixed-use assets owned by all forms of entities except companies that are not close companies (i.e. with more than five unrelated shareholders).
What constitutes private use?
There are three categories of private use.
The first is use of the asset by a natural person (an individual) who is either the person who owns, leases, licenses, or otherwise has control over the use of the asset.
The second is the use of the asset by a natural person who is associated with the person who owns, leases, licenses or otherwise has the asset. For example a close relative of an individual, a partner in a partnership, a shareholder of a close company, a trustee or beneficiary of a trust.
The third category is where the asset is used by a person who is not associated with the owner, but who pays less than 80% of the market value of that use but would exclude an asset that is rented by an unrelated person at a lower price for reasons such as:
- the asset is being rented in an “off-peak” or “quiet” period
- the asset is being rented for a longer period than it is usually rented for
- or the asset is being rented at a reduced price to establish profile or a market share.
Use by a person who falls into one of the above categories will constitute private use even if the person uses the asset along with others – such as when the owner stays in the bach along with some of her friends, even if the friends pay market rental.
Use by a person who falls into one of the above categories will also constitute private use regardless of any amount paid for the use.
When does private use not apply?
In the following situations private use does not apply when the owner uses the mixed-use asset to:
- earn income in the ordinary course of their business. For example, a person who owns a boat and operates a business that provides skippered fishing charters will not be treated as using the boat privately when he or she takes out the boat in the ordinary course of the business.
- carry out repairs caused by someone who rented the asset. For example, a bach might be rented to people who damage it. The owner might then need to stay in the bach to repair that damage because the owner lives some way away, and it will take more than one day to repair the damage. The use by the owner to repair the bach will not constitute private use.
- relocate it at the beginning or end of a period of hire, the relocation is necessary to enable the hire, and the income derived by the owner directly or indirectly includes an amount for the relocation.
References: www.ird.govt.nz keyword: mixed-use