Sunday, January 24, 2010
Mike Butler: Losing money on rentals
Possibly Prime Minister John Key’s comment about “closing loopholes” has sparked debate, especially among commentators who have been campaigning against these companies.
The fact that Mr Key and Finance Minister Bill English have also said they would study the report closely seems to indicate that some action is forthcoming, especially when compared with their reaction to the Brash 2025 Taskforce report, which they ruled out as too radical.
The working group does mention LAQC losses, noting “a marked decline in net rental income since 1999 (has been) accentuated by losses claimed through loss attributing qualifying companies (LAQCs).
A LAQC is a normal company with a special tax status that enables losses to be offset against the shareholder’s personal income for determining their tax liability.
Before the working group report was released, some property accountants had suggested “ring-fencing” property losses, so that rental losses could only offset against rental profits.
The report said that “a consequence of the tax treatment of rental property investment is that the $200-billion investment in rental housing generated net rental losses totaling about $0.5-billion and approximately $150-million in tax revenue losses in 2008”.
The report also noted that 9700 families with rental losses receive Working for Families tax credits.
The report does not specify the extent of LAQC losses. However, figures obtained from the Inland Revenue Department by interest.co.nz show the value of tax losses claimed by LAQCs in 2008 was $2.258-billion. This was more than triple the losses claimed before the housing boom began in 2003.
At least 40,000 LAQCs were registered with the IRD, where the stated LAQC activity included property. About 130,000 LAQCs filed returns for the year, according to interest.co.nz.
My view is that a rental property that loses money every week is not an investment. It is the opposite of an investment.
If the interest, rates, insurance, and maintenance costs exceed the rental income, every week that hapless landlord must top up his rental account with money from elsewhere, usually his or her wage or salary. How much do you want to pay every week for your loss-making rental?
That loss is credited by the IRD by way of a rebate on tax paid on the day job.
The problems with negative gearing, as this loss-making approach is called, are: Who pays the outgoings when the rent is not paid, when there is a vacancy of a week or more, where does the money come from when there is damage to repair?
Worse, what happens if the day job disappears? The newly unemployed landlord can’t pay for repairs, can’t pay the insurance, a rates demand is missed, can’t pay the mortgage, and after a series of terse letters from the bank, the property goes to mortgagee sale.
Now an even bigger problem looms. What if the government ends the ability to offset rental losses against personal income?
Numerous properties bought as rentals during the property boom were loss-makers from day one. An experienced investor would not even need to pull out the calculator to see that that cost of the mortgage would exceed the expected rent on properties that should have been sold to first-home buyers. I have seen property gurus, real estate salespersons, accountants, and lenders encourage naïve mums and dads into these dud investments.
I imagine the recession has already cost the jobs of a number of investors stuck with a loss-making rental.
If the Key government intends to close the LAQC loophole, advance warning is needed so that those affected may reorganise their affairs. This would give the investor time to pay off a chunk or mortgage so the property is profitable, or sell the property.
If the change is sudden, a whole lot more are going to be burned.
A Tax System for New Zealand’s Future, Report of the Victoria University of Wellington Tax Working Group.
LAQC losses tripled to NZ$2.3 billion between 2003 and 2008 http://www.interest.co.nz/ratesblog/index.php/2009/09/08/laqc-losses-tripled-to-nz23-billion-between-2003-and-2008/
at 1:57 PM