I LOST MY DEPOSIT ON MY RENTAL LAND & BUILD – CAN I CLAIM THAT AS A BAD DEBT?

“lost deposit rental property tax deductible NZ.” That’s probably what you typed into the search engine that lead you here. If so, you have come to the right article. But first:

30-Second Summary

• If a developer goes bust and keeps your deposit on a land-and-build deal, the short answer is: no, you can’t claim it as a bad debt.
• Why: the deposit was a capital purchase (buying a long-term asset), not a revenue purchase (buying to resell). Capital losses generally aren’t deductible under NZ tax law, and neither are capital gains taxed — deposits included.
• The wording of your contract matters. If it explicitly frames the payment as a loan to the developer, there’s a narrow (very unlikely) case for bad-debt treatment.
• Legal costs to try to recover the deposit are often not deductible either, if capital-related legal costs exceed $10,000 in the year.
• Your normal rental expenses (see our record-keeping guide) are unaffected and remain deductible.

Let’s make sure we have the scenario and question clear first. You’ve paid a deposit to a company on some land, and they’ll build you a house as part of that deal. The company goes bust and you won’t get your deposit back. (Yes, it happens. All investment has a certain amount of risk.)

The question is, can you write off this deposit as a bad debt? The short answer is no.

Why is this? When you buy in such a scenario, you have bought on what is called “capital account“. That means you are not buying and selling houses to make money on the profits, which is called buying on “revenue account.” Rather, you’ve spent money to acquire or improve a long-term asset such as equipment or buildings. When you sell the asset, at present there is no tax on the capital gain. Likewise, if you make a loss when you sell, you can’t claim that loss. And in the same way, if your calculated risk ends up in losing your deposit, that too is not claimable.

Questions

Q: Is the deposit really a deposit? In other words, could you argue the deposit isn’t a deposit, but rather payment for a set of services — designs, council fees, etc — meaning it isn’t an asset? A: No. This doesn’t really change things. However it may depend on what your contract states. If your contract indicates the money given to the builder is a loan to be repaid (irrespective of its nature), it would possibly fall under the definition of a bad debt. It would be best to check the wording of your contract with your lawyer. If that’s the case, the possibility of claiming this can be examined — though we stress this is very, very unlikely.

Q: The house isn’t an asset at this stage, so shouldn’t the deposit be recorded in the Profit & Loss as an expense? A: No. Again it comes back to purpose. The house was, in this scenario, part of a capital account purchase, not a revenue account purchase. Therefore, the lost deposit is not deductible.

Q: Any company I’ve worked for where a supplier has gone under has been able to capture the loss in the Profit & Loss. What’s the difference here? A: No. That situation is a revenue situation — supplies are bought to on-sell. A supplier is paid for goods it doesn’t deliver, so the undelivered goods for on-sale can be treated as a bad debt, provided matters are handled correctly.

Q: I thought a debt can be written off as “bad” when a reasonably prudent commercial person would conclude there’s no reasonable likelihood the debt will be paid. Isn’t that what the law says? A: Yes but that’s not the situation here. That only applies in a “revenue” scenario, and only where the other requirements are met.

Q: What about legal expenses? Are they deductible? A: Yes and No. If legal action is taken to recover items such as unpaid interest reimbursements (which would have been declared as income, i.e. revenue), the legal expenses are fully deductible if they come to less than $10,000 in one financial year. If more than $10,000, they are capitalised and depreciated.

However, where legal action is taken to recover deposits on land/buildings — items of a capital nature — and this cost exceeds $10,000 in the financial year, the portion of legal costs related to this would not be deductible.

The converse is also true: even if your legal costs are a mix of capital and revenue items, the entire amount can be claimed so long as it doesn’t exceed $10,000 in one financial year.

Q: So does that mean nothing is deductible? A: No. Your usual rental expenses (see here for a sample list) are still deductible.

Further Questions

• Some contracts with developers include a provision requiring the developer to reimburse interest costs incurred during the build. These are sometimes paid as a credit to the client’s bank account, other times deducted from a progress payment. Could these be viewed as a loan of sorts to the developer (given the legal obligation to reimburse) and therefore qualify as bad debts?
• Some contracts also specify the developer will pay a rental top-up of $50/week or similar for the first 12 months. Could this be treated the same way?
• Some contracts specify the deposit is for designs, engineering, and council consent. Since consent isn’t guaranteed, does this change the deductibility of the costs?
• Given significant rises in the Auckland property market, could a client resolve (via company resolution, since most have purchased through an LTC) that the project will now be sold with the intention of making a profit — subject to capital gains tax — effectively reclassifying it as a “revenue” rather than “capital” investment? Would this incidentally mean deposits and progress payments could be written off as bad debts? Or would this risk being viewed as tax avoidance?

Please see the file below for detailed answers to these questions:

Download File: brandt_segedin_letter.pdf

Key Takeaways

• A lost deposit on a capital-account purchase is not deductible — the same principle that shields capital gains from tax also blocks capital losses.
• Contract wording is the one thing that can change the answer. Only a genuine loan arrangement opens the (narrow) door to bad-debt treatment — have a lawyer confirm this, don’t assume it.
• Legal costs to chase the deposit have their own $10,000 threshold rule — mixed capital/revenue legal costs are only deductible in full if the total stays under $10,000 for the year.
• Reclassifying the investment from “capital” to “revenue” intent is not a simple workaround — it can carry real tax avoidance risk and needs proper advice, not a resolution passed after the fact.
• Your ordinary rental expenses are untouched by any of this and remain fully deductible.

What to Do Next

If a developer or builder has gone under and you’re facing a lost deposit, don’t rely on a general blog post (including this one) to settle the tax treatment — the outcome hinges entirely on the exact wording of your contract. Take your contract to your lawyer and have them confirm, in writing, whether the payment is structured as a deposit or as a repayable loan — that distinction is the one thing that can change the answer. Once you have that legal view, we can advise on the tax treatment that follows from it.