Residential vs Commercial. Do the tax settings demand a new strategy?

There has been so much focus on the tax changes to property of late that it’s easy to forget that there are different types of property investment and they are most certainly no longer treated equally or fairly under the existing tax laws. 

There is now a stark contrast between “Residential land” which is essentially property with a dwelling on it, or capable of taking a dwelling, and commercial property. 

This article serves to remind us of some of the significant tax changes that differ between residential and commercial. In the hope that it may trigger some readers to consider adding commercial to their portfolios, as an alternative to simply halting their property investment strategy altogether, under these tax settings. 

When you start considering commercial, most of us immediately think a shop, or an office but commercial property comes in many shapes and sizes. Something as simple as a carpark space is in fact a commercial property and commercial, in the tax sense, can also include rural property like farms, vineyards and forestry blocks. 

So, what are the key tax differences between commercial and residential from a tax perspective now? 

1. Depreciation. From 1 April 2020 the ability to depreciate commercial buildings at 2% was reinstated as a Covid-19 relief measure. There is still no depreciation allowed on residential buildings. 

2. Depreciation of Chattels and building fitout. Whilst there is a modest list of residential chattels that can be depreciated if they are not physically attached to the building, the list of items that can be depreciated within a commercial building is extensive. The ability to depreciate these at much higher rates than the building rate provides a generous deduction that is not impacting cashflow at all. 

3. No Loss Ringfencing. With all the focus now in the theoretical profits people will be taxed on, without the benefit of an interest deduction for existing stock residential investment, it’s easy to forget that the first tax change Labour made was to ring fence residential tax losses. This prevents a loss from being offset against any income other that residential rental. A tax loss on a commercial property investment is not ringfenced though, meaning it can be offset against other income, offering an immediate and material tax saving, especially for those in the new 39% tax bracket. 

4. No Brightline. Whilst residential investors are tied up in knots by the dilemma over whether to opt for a new build with a 5-year Brightline or an existing stock property with a 1o year Brightline, commercial acquisitions have no Brightline at all. 

5. Interest deductibility. The shock news that the deductibility of interest would be removed on residential acquisitions of existing stock residential and phased out for existing residential investment loans, stands in stark contrast to lending for commercial property where full deductibility of interest is available. Interestingly, its also available if you use residential property, you already own to secure a mortgage that is used to buy commercial property. It’s the use of the borrowed funds that matters, not the security. 

6. GST. Residential property investment remains an exempt activity for GST whereas commercial property is generally subject to GST. Being GST registered though, for a commercial investment, has no bearing on existing residential property. Investors would be sensible to gain an understanding of the compulsory zero rating rules that apply to property transactions but the need to be GST registered, in and of itself, should not be a barrier to entry into commercial property investment. 

Finally, many people shy away from commercial investment because it’s perceived to be a little bit harder to get to grips with than residential. It’s certainly true that length and strength of lease is a main driver of value in the commercial property arena and gaining an understanding of leases and sqm rent rates in a particular area can be a bit daunting. 

For those that are new to commercial property investment and management that want to make an acquisition, consider using the services of a commercial firm offering a buyers advocacy service. There are some quality firms in the market with many years of experience that can be engaged to assist with making an acquisition and managing lease obligations so again, a lack on knowledge of the market or the process doesn’t need to necessarily exclude a first-time investor from making a commercial property investment acquisition.