COMMENT: Property investment tax advantages

Anthony Appleton-Tattersall

Did you come here looking for details about the tax loopholes enjoyed by property investors?

It is common knowledge after all that property investors don’t pay tax, because of all the tax advantages enjoyed by the asset class.

But as is often the case with common knowledge, it’s also total baseless nonsense.

Residential property does get several specific sections in the Income Tax Act, but none provide advantages. They instead make it the worst-taxed investment class available except a term deposit.

In short, the tax regime in New Zealand is exceptionally harsh on residential property. But it remains a fantastic investment class due to friendly borrowing terms. In detail? Read on.

The property-tax-advantage rhetoric stems back decades. It was huge in the 1990s when advisors were touting negative-gearing schemes.

Borrowing to the hilt to buy as much as possible, generating losses each year and a corresponding tax refund – meanwhile, the property value rises faster than the annual losses, tax free.

So is the tax advantage the ability to negative-gear and get a refund for your losses? Not at all! Until very recently this could be done on any investment.

A business that makes a loss can offset this loss against other income. Your investment in shares or forestry or gold, if you’ve borrowed to buy it and makes a loss, you can get a refund as a result.

Note the words “until very recently”… Residential property has recently been singled out as the only class which you can’t deduct your losses and instead have to carry these forward.

An explicit tax disadvantage versus anywhere else you could put your money.

So then the tax advantage must be a lack of capital gains tax. It is true New Zealand does not have a capital gains tax; the only OECD country not to.

But this fact isn’t property-specific. Capital gains on shares, businesses, classic cars, art, jewellery, stamps, or your Pokemon card collection are all tax free too.

Unless of course you’re buying them specifically to sell, then that’s another matter – and it’s the same with property, those who regularly buy and sell are subject to tax and often GST too. All fair so far.

But property gets special treatment, where capital gain is explicitly deemed to be income and taxed accordingly. No other asset class is targeted in this way.

Subdivision tax law and association to a builder or developer are examples, but the most recent is also perhaps the most common and well known: The bright line test.

The bright line rule is an excellent concept. But it was poorly drafted into law, creating massive potential for tax liability outside of the desired scope of catching property speculation.

For many years, and still now, any property purchased with the intention to sell it (a “flip” or “trade” property) will have tax levied on any gain. There is no time restriction here, taxable forever.

But prior to 1 October 2015, it was far too easy for unscrupulous or ignorant people to buy and sell property for profit and fail to declare their income. And tough for the IRD to prove intention.

The new system for recording and reporting on property sales allows IRD to track and catch non-compliance far easier. This is a good thing.

I have several gripes with the bright line legislation, but my most significant one is a lack of exemption for related party sales. In what world is a restructure to your own trust, taxable speculation?

Then, there’s the unnecessary extension to five years. Two years already caught the speculators. Extending also creates a precedent for future increases. A capital gains tax by stealth – but only on houses.

The only asset classes more-disadvantaged are cash and term deposits. These do not experience value growth, so you’re taxed on the entire return – most of which is just meeting inflation.

Where property has clear and unfair advantage over other asset classes is the ability to cheaply leverage.

A mortgage at 80% is standard, and 85-95% entirely possible particularly for property purchased as a home and rented later. Lending is at the best available rates, presently around 2.5%.

Some banks lend for investment in shares (“margin lending”) but only to specific approved securities, with lending capped at 40-70%, and interest rates of 4-5%.

An unsecured loan to operate or grow a business tends to cost upwards of 10%.

Is it any wonder generations of Kiwis continue to gravitate to property?

*Anthony Appleton-Tattersall operates AAT Accounting Services (at www.aataccounting.co.nz), a specialist accounting firm for the property sector.