Throughout the leaky building crisis, there has been significant uncertainty regarding whether the remediation of leaky buildings constitutes deductible repairs or non-deductible capital works. Precedent cases are typically very old, dating back to decisions involving the remediation of railways and gas pipe systems.
The lack of a modern case likely stems from the financial devastation that often accompanies a leaky building issue, leaving affected individuals without the financial or personal resources to challenge the Inland Revenue Department (IRD). However, a recent decision in the case of E & G Lawrence v CIR offers some clarity on the matter, though it unfortunately does not favor investors facing extensive remediations.
The Lawrences purchased a freestanding fibrolite-clad house in Tauranga in 2014 for $350,000, with a government valuation (GV) of $305,000. They commissioned a non-invasive visual building inspection, which concluded that the house was well-constructed and in good condition for its age.
Kitchen Leaks
Trouble began in 2017 with reports of leaks in the kitchen, attributed to internal guttering and poor roof design. Although the guttering was replaced, the leaks persisted, necessitating a redesign of the roof and guttering and addressing the lack of window flashings. The cladding, which had no cavity, was also considered problematic. The Lawrences opted for a comprehensive approach, undertaking works to redesign the roof, guttering, and reclad the building, which required consents.
Inspections as part of the consenting process revealed non-compliant stud work, inadequate drainage, and a rotting deck that needed replacement. To replace the deck, a retaining wall also needed redesign and rebuilding. It was a classic case of discovering more problems as more layers were peeled back.
The Lawrences claimed $61,140 of costs in 2018 and $303,654 in 2019. A Code Compliance Certificate (CCC) was ultimately granted for the works, and a valuation for the bank in 2018 assessed the property at $700,000.
The IRD reviewed the claims and sought to deny them, citing the capital limitation in section DA2(1), which denies deductions for works that are capital in nature. There was no dispute over the general permission to deduct expenditure in section DA 1(1), as the property had always been a rental property for the Lawrences, thus retaining a nexus with income.
Remedy In Courts
The Lawrences initially entered the dispute resolution process but ultimately opted for a court remedy. The legal process focused on precedent cases and centered on identifying the asset being worked on (clearly the building) and the nature and extent of the work undertaken. This comprises three tests:
- Whether the work resulted in the reconstruction, replacement, or renewal of substantially the whole of the asset.
- Whether the work changed the character of the asset.
- Whether the work formed a single project of work.
In court, both parties presented expert witnesses. The judge favored the evidence presented by the IRD’s building expert, who testified that the redesign of the roof, replacement of joinery and guttering, and recladding of the building substantially reconstructed the house, altered its character, and extended its life. The fact that the Lawrences were unaware of the defects when they purchased the property, and that much of the work was required as part of the consenting process, did not support their argument that the work was deductible repairs.
Ultimately, the judge found in favor of the IRD, ruling that the works were capital in nature and non-deductible. He also stated that the decision was “very easy” and “a clear-cut case.”
‘Extent And Degree’
This led to the IRD reassessing the Lawrences’ tax returns and denying the deductions for the remediation claimed as repairs. Costs were awarded to the IRD.
This case now reinforces the “extent and degree” arguments that the IRD frequently cites in cases involving remediation, making it more challenging for investors to establish that extensive remediation remains repairs to the building rather than non-deductible capital works.
While the decision is not what investors would have wanted, I would like to thank and acknowledge the Lawrences for their tenacity in taking on this case and arguing their position despite the devastating impact the need to remediate their investment must have had. We are now clearer on where the line lies between deductible repairs and non-deductible capital works. My hat goes off to you for taking on this fight after all you had been through with the remediation.