LOST DEPOSIT RENTAL PROPERTY TAX DEDUCTIBLE NZ?

“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(opens in new tab)“. That means you are not buying and selling houses to make money on the profits, which is called buying on “revenue account(opens in new tab).” Rather, you’ve spent money to acquire or improve a long-term asset(opens in new tab) 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: Sometimes. You can deduct legal fees used to recover unpaid interest reimbursements. Those reimbursements must be taxable income. You can claim the full deduction if total legal fees stay below $10,000 for the financial year. If legal fees exceed $10,000, you must capitalise them and claim depreciation instead. Different rules apply when legal action recovers deposits paid on land or buildings. Land and buildings are capital assets. If capital-related legal costs exceed $10,000, you cannot deduct that portion. You may incur legal costs for both capital and revenue matters. You can claim the entire amount if total legal costs stay below $10,000 for the 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?
• Property values might increase significantly. Could a client pass an LTC resolution stating they now intend to sell the project for profit? Would that change the investment from capital to revenue and make any gain taxable?

Please see this file for detailed answers to these questions: Download File: brandt_segedin_letter.pdf(opens in new tab)

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. Check with your lawyer to 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.