Possible changes to the Legislation relating to Investment Property and GST

The 20 Second Update

• Net change to your current situation $6 per week. (click here for detailed model)
• On average, over 10 years,  an investment property will cost $70 more per week to own
• The likely drop in personal tax rates will increase take home pay by $64 per week

If you want the detail, below we cover:

• The recommendations of the TWG were…
• John Keys Announcement
• Tax Change Summary
• Why is property being targeted?
• Affect on  investors
• Is property still a good investment if the above recommendations are implemented?
• Conclusion
• Recommendations
• What are the other experts saying?

The recommendations of the Tax Working Group (TWG) were as follows:

• Align tax rate for Company (30%), Trust (33%), Personal (39%), PIE (30%)
• Reduce top personal tax ratesReduce Company Tax Rate
• Retain Imputation System
• Comprehensive Capital Gains Tax
• Risk Free Return on equity (click here for explanation Apply a Risk Free Return Method)
• Low Rate Land Tax
• Remove depreciation on non-depreciated items (buildings) and 20% loading for plant & equipment
• Change thin Capitalisation Rules
• Increase GST to 15%
• Review Welfare Policy including Working for Families

The TWG did not recommend the following:

• Changing the LAQC Regime (click here for explanation Understanding the LAQC Regime)
• Ring Fencing Property Losses (click here for explanation Ring fence losses on rental property)

In the above recommendations, the worst situation for property investors would be the Risk Free Return on equity.

John Key’s announcement

Said the tax changes would be announced in the May 2010 Budget. He has ruled out the following:

• Land Tax
• “Comprehensive” Capital Gains Tax
• Risk Free Return Method

But has suggested:

• GST will probably increase to 15%
• No major changes to Working for Families
• Will change the way property is taxed
• Other options remain on the table from the Report

Other matters to be reviewed, relating to property:

• Residential Tenancies Act
• Home Insulation Program

There could be a “Restricted Capital Gains Tax” such as one applying to investment property sold within two or three years of purchase.

Summary

	Ruled out	Possibility	Likely
Align Company, Trust, Personal & PIE tax rates
Reduce top personal rates
Reduce Company Tax
Retain Imputation System
Capital Gains Tax
Risk Free Return for Property Investors
Land Tax
Remove claim on Building Depreciation & 20% Loading
Increase GST to 15%
Review Working for Families

If GST is increased, it is likely to commence 1 October 2010. We can’t see the tax changes regarding deprecation commencing until the financial year 1 April 2010 – 31 March 2011, as there already would be a number of returns filed with the IRD for the March 2010 financial year before the May Budget is released.

So we now know what is excluded and up for review in the Budget to be announced in May.

Why is property being targeted?

The NZPIF (New Zealand Property Investors Federation) believes that rental property is being unfairly targeted due to a strong bias and lobbying from the financial services industry. There are many incorrect and misleading public comments that have been deliberately made creating a misconception within the general public.

Probably the greatest misconception is that rental property owners do not pay tax, but are instead net taker of tax money. This idea has been generated by continually referring to the year 2008 when rental property made a combined loss of $500 million. However this is when interest rates were at their highest and was to be expected. Rental Property owners have been net tax payers for 26 of the past 28 years according to an IRD / Treasury report last September - refer to

http://www.apia.org.nz/news-articles?articleurl=Tax-changes-and-property-- what-can-you-do-

Another misconception is Investors have been blamed for “pushing up the property prices”. This is not correct. Investors purchase at valuation or less. It is down to the “numbers” to make it as cashflow neutral as possible. There is not the same emotion as when you are purchasing a family home. We know of two instances very recently that home owners paid up to $200,000 more than valuation to get the property they wanted.  It is these home owners who are further pushing up prices, driven by pure emotion.

Affect on investors

• With what has been suggested that pertains to Property Investment:
• Remove tax deprecation on buildings if they do not depreciate in value
• Remove 20 per cent loading that applies to new chattels in the building
• Increase of GST from 12.5 per cent to 15 per cent
• Tax Relief

There will be a small number of investors, for financial reasons, who sell their properties as they will not be in a position to pay the additional money to fund their investment property (refer below to “Is property still a good investment… for further information). It will not be the investors with one or two properties that could sell some property, but those who have larger portfolios. For each property, they have the multiplication of numbers with increased outgoings. Of course they also have the multiplication of numbers with growth as well. As long as they can sustain the extra funding, there should not be too much of a problem. For those with tight cashflows, will sell a property or two, however that will result in a shortage of rental properties available.

Rents will also go up, maybe not immediately, but combined with a shortage of properties and some recovery of the higher outgoings, and the costs will be passed onto the tenants to some extent, so the extra funding required of say $30 per week could be very easily compensated by rent increases of a similar amount. There could be a slight over-supply of property for a short period of time, resulting in some lower property prices until it balances out.

New Zealand has approximately 460,000 privately owned rental properties which are home to at least 1.4 million tenants (information from Property Investor’s Federation). Housing New Zealand runs 69,000 homes of which a very small number are owned by private landlords (currently there is a waiting list of 10,000 families with HNZC). We are not sure how the Government will handle any housing shortfall and rental increases as a result of this move.


Depreciation:
The recommendation is to remove the 3% on the building value of the property by the TWG, which generally does not depreciate.

Depreciation is a “free loan” and there is tax on deprecation recovered on sale, so this would no longer apply. You are paying a little more upfront, and not upon sale. It has an impact of personal funding over a ten year period of about $25,000. This would be about the amount in tax on deprecation recovered upon sale, so swings and round-abouts. The Government is just collecting the money upfront instead.

Removal of the 20% Loading for new chattels (plant & equipment).  This applies to the purchase of new assets only (e.g. carpet normally 40% deprecation, however if new you can claim 48% deprecation). All chattels would be deprecated at their basic rate as set down by the IRD.

There has been no mention of the removal of the Chattels Depreciation. The Report only refers to the building value of the property. It would therefore be prudent to ensure that you obtain a full chattels report from Valu-it (or similar company), who individually breaks down the chattels from the building and fit-out items. Without this report, you can not claim the full depreciation claim allowable on the chattel. Currently if there is no Chattels Valuation, the chattels are depreciated  with the building at the rate of 3% as the value is combined. Failure to have a Chattels Valuation could result in no deprecation allowance at all of your Chattels, therefore further increasing your personal funding.

GST increasing from 12.5% to 15%
All costs increase by 2.5% and that increase will drive up property values within a reasonably short period of time by a similar amount. Simplty the cost of building a new property will increase by 2.5%. An example is say on a $450,000 property, 2.5% increase represents an increased property value of more than $11,000, in year one. Property prices since 1992 have gone up by an average of 6.9% each year, let’s be conservative and apply 5% growth per year on the increased value of GST. Your $450,000 investment after 10 years has increased in value a further $17,000 from $733,003 to $750,000.

Tax Relief
The New Zealand Herald (10 February 2010, Page A3)  suggests the following as the possible tax cuts:  

This would considerably reduce the “hit” taken by the Property Investors. If there was no tax reduction, it would cost an investor about $60 per week to fund their property with the removal of  the 3% depreciation allowance. However, combine with the above tax reductions, makes the personal impact acceptable, as it would cost an investor approximately $30 extra per week to fund their property in year one and jsut $6 per week extra over 10 years.

Is property still a good investment if the above recommendations are implemented?

Let us look at an example on the change in personal contribution for a new property worth $450,000, receiving weekly rental of $450, average growth 5% per annum (since 1992 this has been 6.9%), 7.7% interest rate (interest only) with a person earning $80,000, with the removal of building depreciation and 20% loading on chattels depreciation and the implementation of the tax savings:

The following would be the value and the equity achieved:

So what does this mean, when you make allowance for the tax savings,
Over 10 years,  it will cost you $36,892 more out from your personal income, however $33,569 of this is credited back to you via the additional take home pay (reduced taxes), giving a net result of a gain of an average of $6 per week over the 10 year period.

Now we need to look to the government website www.sorted.org.nz to confirm what is recommended savings to meet your funding for retirement…

Let’s say the above investor is age 45, earning $80,000, the partner earns $50,000 and has 20 years until retirement, a current mortgage on the family home with no major savings.

Combined savings per month is $1,943 ($448 per week) is required, resulting in saving pool at retirement of $634,451, saved over 20 years. Compare this with property, an outlay of $141,205 (average $135 week) in Year 20 with equity achieved of $743,984, and remember that some of this outlay is funded by the tax savings.
You are financially better off by $313 per week, saving you over $500,000 over a 20 year period…
The numbers speak for themselves….

Conclusion:

Of the options that apply solely to rental property, disallowing deprecation claims would likely have the least negative consequences for rental property owners.

A Capital Gains Tax, Ring Fencing and a Risk Free Return are the largest concerns as they would have a large and negative affect on the industry.

Recommendations:

Refer to the Auckland Property Investors website, they have a good paper on the topic, points on the TWG’s recommendations and what they are suggesting you do.

http://www.apia.org.nz/news-articles?articleurl=Tax-changes-and-property-- what-can-you-do-

Write to your local Member of Parliament and let them know how you will be affected by the proposals. While you can use this report to help provide information, make your letter as personalised as you can, as this carries more weight. We do not want the Government to introduce Capital Gains Tax, Ring Fencing or Risk Free Return.

Also, send the same letter to the following, as they are key decision makers on this topic.

  

What are the other Experts saying:

One of the country’s foremost property accountants (Mark Withers) said in a Letter to the Editor (NZ Herald) on 6 November 2009…

“the only reason’s why investment property has losses is because:

a)    our rents are too low in comparison with other countries
b)    our interest rates are too high

If either of these were brought back into line with other countries (let alone both), properties would not run at a loss.”

The suggestion of removing tax depreciation would therefore solve one of the issues Mr Withers has raised, as rents would increase as a result of the shortage of properties if some investors sell up.

Martin Hawes, leading Financial Advisor stated in the Sunday Herald on 27 September 2009…

“There is no evidence that waving a tax stick causes people to flee property. Other countries have capital gains taxes and ring fence tax losses as well, but they have still had a property boom at least as great as ours.”

Matthew Gilligan, Prominent Property Lawyer and Accountant, from Gilligan Rowe & Associates, states on Property Talk 20 January 2010…

“Another thought regarding depreciation that has been written by others no doubt, is that it is only a timing gain for the government.  After all everyone sells at some time (death or before), so eventually the depreciation is recovered anyway. So why bother?”

Alistair Helm, CEO of Real Estate NZ stated in the New Zealand Herald on 20 January 2010…

“he did not believe any of the proposed tax changes would dramatically change the property market in New Zealand”