Investment property tax and the budget - what to do.
We have been saying for a while now, that any radical changes to the current tax regime affecting investment property will ultimately be passed on to the tenant.
Quite a number of investment property owners have called us recently asking whether they should sell their investment property now, or wait until the budget announcement. A few astute free thinkers have even asked, "Should we invest again now?"
Now that much of the wild media speculation has died down, we thought you would appreciate some considered thoughts about the future of residential investment property in the major cities of New Zealand.
In the lead up to John Key's Budget address on 20th May 2010 there has been plenty of speculative nonsense talked by people with their own agendas. Fundamentally, the Tax Working Group had been charged with suggesting many options from which the government could choose the most appropriate mix. In Mr Key's announcement, he quashed the introduction of a Capital Gains Tax, Land Tax, and Risk Free Rate of Return Tax (RFRM).
Mr Key, however, did say he was "carefully considering" an increase in GST, to 15%, which would be the main source from which the government will fund the proposed reductions in marginal tax rates.
Further, Mr Key said that at budget time there would be changes aimed at property investors. He said there were gaps in the tax system "around property investments where income is being derived but, in aggregate, no tax is being paid - in fact the government is actually losing revenue in this sector."
"We will therefore be making changes the way property is taxed, which will result in increased government revenue and more fairness to tax payers."
A lot of commentators were concerned about what Mr Key left unsaid in his address, but those who followed up the speech with the aftermath of media appearances, found the TV interviews most enlightening. In a post-speech TV interview, he broadly hinted that the budget will include the removal of depreciation allowances on investment buildings. When closely questioned, he also confirmed 'mum and dad investors' would remain able to offset genuine costs against their income, which clearly suggests that ring fencing of tax losses is not likely.
Recently, Mr Bill English has spoken about the government looking to ensure genuine tax losses on property are not used to gain extra benefits from the government, such as the generous "working for families" allowance.
The team at Iron Bridge have a clear view for you to consider:
You should breathe a collective sigh of relief that all of the potentially devastating tax regimes are off the agenda. (see paragraph 4)
Further, although not exactly spelt out, a pragmatic John Key has effectively said that ring fencing of tax losses is off the agenda.
The depreciation of chattels, which is most effective with new or near new property will not be addressed. After all, heat pumps, drapes and carpets all wear out.
An increase in GST to 15% will increase the cost of a new house by in excess of 2.5%. (This represents immediate capital growth for those invested now)
An increase in GST to generate about $2 billion is necessary to fund a reduction in the marginal tax rate from 38c to 33c.
Our average investment owner would be no worse off in this situation. (Compare for example $1000 in reduced marginal tax verse $1000 reduced tax rebates from total elimination of depreciation on residential buildings = No net Change).
If depreciation is eliminated from all residential property, the reductions made several years ago to chattels depreciation must now come under further scrutiny. The argument then was electrical reticulation, plumbing and internal partitions were to be moved into the area of building depreciation. Those three items would no longer be sustainable at 0% depreciation. Iron Bridge's view is that chattel depreciation allowances will increase. It is conceivable that with tax deductions eliminated on residential building structures, in real terms, the amount of money that one can claim on a new property in the chattels area would increase substantially.
All those who have owned investment property for a considerable time need not be fearful, as in the long history of National led governments, never has a new or increased tax been retrospective. Those benefits you have enjoyed to date, and maybe in the future are safe.
So. Iron Bridge's view is clear. We see the depreciation allowance on a residential building structure, reduced to zero. Even a 1% per annum diminishing value depreciation allowance would see a house structure halve in value in 72 years for tax purposes. However, even that would seem unjust when one looks at old villas in Auckland that cost less than £1,000 to build, that now have rateable values in excess of $300,000.
Now here is where the government needs to be careful Iron Bridge's view is that any negative change to the financial environment in which you invested, beyond that which we described above, requires a response to return matters to an equilibrium as soon as possible.
The obvious place is to look to the tenant.
You are in a business after all, the business of providing a quality, high demand property in the rental market. If this business is threatened with increased expenses to the owner, via the government or any other source, you have no choice but to pass on these costs to your customer - the tenant - with a rent rise.
Anything more radical than reducing residential building depreciation would have a heightened flow on effect, which would end up at the feet of the tenant, faced with less choice of modern properties and much higher rents. The tenant looks doomed to spend all of his/her tax cuts on rent increases.
What many commentators and those knocking property investment have conveniently forgotten is that the present tax arrangements affecting property were put in place to achieve several simultaneous goals.
1. To strongly encourage the private sector to provide the housing the government could not or would not provide.
2. To free the government up to focus almost solely on low cost affordable housing.
3. To support the building industry - a major power house of the New Zealand economy.
4. To maintain the housing supply for a growing population, where currently one new person (net) is added to our population every eight minutes. (Statistics New Zealand, March 2010)
Tony Alexander, Chief Economist at BNZ, maintains that at our current migration rate, New Zealand has to build 46,000 houses in the next 5 years. We ask what rational government would seek to decimate simultaneously the building industry, the financial future of prudent 'mum and dad investors' and pass the entire burden onto tenants who must inevitable pay more rent and who will ultimately vote in a Labour led Government to turn it all around?
Our view is the most likely, (re-cap) - just the depreciation allowance removed from residential building structures (not chattels). Already Iron Bridge is pushing hard to ensure all rents are at the best above-market rent we can achieve this. (Ask us for the statistical comparison on how good we are compared with the whole market.) Any changes beyond this depreciation factor (which is highly unlikely) could see a short term drop in existing property values, followed by a rapid rise in rents when supply dries up, then rapidly increasing property values.
Brent Smith
Managing Director
Iron Bridge Property Investment
