Property investors on notice

Investors in property, such as in these buildings in central Dunedin, will be affected by changes to taxation rules likely to be included in the May Budget. Photo by Linda Robertson.

WHK taxation principal Scott Mason is under no illusions about the tax changes signalled by Prime Minister John Key around property ownership.

"It is clear the end is nigh for taxpayers who have been making losses on property investments and then offsetting those losses against other sources of income."

The Government's concern was that the investment property sector - particularly residential properties - tied up a relatively significant proportion of the country's investment capital while the return to the Government through tax was negative, he said.

The distortion was underpinned by the current tax system which rewarded negative gearing and encouraged otherwise insufficient returns, as compared to the "productive" sector.

For many investors, the holding of residential properties was only achievable due to the generation of tax refunds each year, while their desired underlying economic return relied on capital gains arising out of the eventual sale, Mr Mason said.

The example provided by WHK assumed someone buying a rental property for $400,000, funded 80% by debt at 6% and rented out at $20,000 a year.

The owner would pay $10,000 of rates, insurance and repair costs each year, on average.

That would leave an annual cash loss of $9200.

Under the current rules, after they claimed a tax deduction for the non-cash expense of depreciation of about $8000, they had a tax loss of $17,200 which resulted in a $6500 tax refund of PAYE paid on their salary.

That meant the true cash loss was reduced by the Government's contribution down to $2700.

"The Government's concern is that your investment decision was inappropriately influenced by the impact of the tax refund, as compared to other investments you could have made into the so-called productive sector."

Whether the realignment was to be achieved by removing depreciation from buildings, and therefore reducing the loss, or ring-fencing property losses, was unclear.

The budget on May 20 was expected to contain further details, although the strong signal so far was that depreciation claims were gone, he said.

A key driver to both the immediate impact and effectiveness of revenue for the Government would be the timing of the implementation.

If the new rules were applied to existing property holdings, owners might be forced to sell in a market where others were also forced to sell.

So far, no distinction had been made between residential rental property and commercial property.

On top of the new associated persons' provisions, which were being applied much wider to land sales that were not previously taxed, plus the aggressive views being applied by Inland Revenue to tax from property sales, the tax story might be far from over for those investing in property, Mr Mason said.

Deloitte Dunedin associate tax director Peter Truman said New Zealanders had a love affair with property investment.

The current rules generated about a $500 million loss of tax revenue for the Government on about $200 billion of investment.

That investment was four times the size of the New Zealand sharemarket but whether investors would move away from property and into shares was up for debate.

New Zealanders liked property because it was tangible, something they could drive past and look at.

The Government had signalled it wanted to drop the top tax rate from 38c to 33c but to do that it had to find the revenue from another source, such as the proposed taxation changes on property, he said.

That would mean a redistribution of tax among the 10% of taxpayers on the top tax rate, the ones most likely to be the owners of investment properties.

Many people bought into property because it was possible to borrow against the asset.

Not too many lenders were keen to put up money for investments in shares, Mr Truman said.

"There are some positive benefits from the high level of property investment in New Zealand.

It provides a rental stock which perhaps the Government might not be prepared to do to replace private investment.

"It is relatively easy to build up equity in property and when you retire, you are less likely to be a burden on the state if you have other income."

Mr Mason said the public should be clear about the proposals.

"These changes are actually about using the tax system to achieve social and economic agendas; freeing up capital in one sector - property - and into another sector - capital markets. Irrespective of rhetoric and fairness to the poor investor who is being stranded in the middle, this is a macro-economic issue, not a tax issue. Tax is just the sledgehammer being used to crack the nut."

dene.mackenzie@odt.co.nz.