Thursday, May 20, 2010

Mike Butler: The Budget and property investors

How bad did Budget 2010 get for property investors? The expected hit on depreciation deductions on buildings eventuated, from April 1 next year, with an unexpected proviso it applies to rental housing and office buildings with an estimated useful life of 50 years or more.

The fact that depreciation is recovered by the Inland Revenue Department on the sale of a building has largely dropped out of the debate on the issue. The absence of depreciation can increase annual tax substantially. A pre-and post Budget comparison shows the difference.

For instance, a sole trader investor who owns 10 multi-tenancy residential rentals in his or her own name with a before-tax income of $120,241, claiming depreciation of $24,147, before Budget 2010, had a taxable income of $96,274, and tax to pay of $26,134.

After Budget 2010, without depreciation and using the new income tax scale in which income up to $14,000 will be taxed at 10.5 percent, down from the current 12.5 percent; tax on income from $14,001 to $48,000 will be 17.5 percent, down from 21 percent; income from $48,001 to $70,000 will be taxed at 30 percent, down from the current 33 percent; and the top tax rate, on income over $70,000 will be cut to 33 percent from 38 percent; that investor would pay $30,597 in tax, an extra $4463.

The GST increase to 15 percent would add a further $2917 to the $145,874 total expenses. In other words, that sole trader investor would be immediately worse off by $7380, assuming his buildings were deemed to have a useful life of 50 years or more.

In other changes relating to property, the government is removing the 20 percent accelerated depreciation loading for new plant and equipment purchased after Budget day. Property investors will be prevented from using rental losses to inflate Working for Families eligibility and payments, from April.

Inland Revenue will get funding over the next four years to target property speculators who have been avoiding paying tax on their trading gains. There will also be changes to tax rules for qualifying companies and loss attributing qualifying companies, so shareholders cannot deduct loses at their marginal tax rate and pay tax on profits at the lower company rate. That comes into effect next April.

It could have been worse, if the John Key led National government had opted for a capital gains tax or a land tax. The targeting of LAQCs was a long-time coming. I have always avoided negative gearing since the negatively-geared one just needs to lose the day job to find oneself bankrupt. However, there will be a number of investors with little equity who could go over the edge as a result of this change, meaning they would most probably seek to cut their losses and sell.

Yes, many investors own and run rental properties to make money, a fact that seemed to surprise Sean Plunket when he interviewed Andrew King, who is vice president of the New Zealand Property Investors’ Federation, on Morning Report today. The sector has been inaccurately depicted as an opportunity for wealthy people to avoid tax.

Finance Minister Bill English commented this week that New Zealand cannot become rich by people selling houses to each other. What English does not seem to appreciate is that while workers are processing the food that is grown on the land, that is and has always been the backbone of the New Zealand economy, they do need to live somewhere.

The property sector is a part of the economy. Ask the builder, plumbers, electricians, cleaners, painters, gardeners, architects, and councils, all of whom exist off the back of the property sector.

An enlightened government would seek to foster partnerships with property investors, not use them as scapegoats to deflect attention away from bloated government, and policies to please special interest groups.

Some of English’s tax changes for property are largely a knee-jerk reaction based on faulty advice on a poorly understood sector.


Anonymous said...

Ever since this budget round started I got the feeling that property investors were going to become scapegoats so National could claim they were cracking down on "rich" scam artists, and so take the heat of other tax changes to advantage higher income earners. Your column, Mike, has now confirmed in my mind that that was their despicable plan. The reality is that there weren't any scams going on. The only problems associated with depreciation that were identified were timing issues. I used to think National was a party of principle - but that view didn't last long! They haven't even tried to address the waste associated with the "bloated" government sector. That is the major problem associated with our economy and that is certainly not the fault of property investors!

Anonymous said...

I don't disagree with your comments but in my view property investors have got off lightly. They can still offset their tax losses, which will be a little less now that the depreciation deduction has gone.

On the subject of depreciation, property investors must admit it was a little unusual that they could claim depreciation on an asset that is increasing in value (due to building cost inflation). It's not like a car that has little or no value after ten years, or a computer that it trashed after three.

The depreciation debate shoudl now turn on to what is the government going to allow as an repair and maintenance expense. Will it continue to argue that replacing the roof is capital expenditure that can't be expensed? What will their view be on a new kitchen or bathroom. My thinking is they would now have to accept that as an expense because those items do not appreciate in value. Kitchens and bathrooms for example need to be replaced every 10 or 15 years, expecially in rental situations. Surely now whatever is spent on the property can be expensed? Any thoughts?

Anonymous said...

To say that there were no scams going on in property investment is simply not true. Some property investors were renting their own property from themselves and claiming tax refunds, a bit like tax deducting interest on your own family home mortgage. Depreciation claims broken down into all the components of a house like plumbing, electrical, wooden framing and construction etc.
"The sum of the parts is greater than the whole", giving larger depreciation claims than the "house" on it's own would have.

These type of persons are the ones that compromise a sensible investment opportunity for others.

Property investors provide a social service in supplying housing to people probably not ever going to own their own home for whatever reason, a role that the government did and still does. Imagine what taxes would be if private housing investment was not allowed?

The budget did enough to stem the hard core abusers but not enough to destroy the industry.

Anonymous said...

Scams are not confined to any one sector (although one must admit lawyers appear to make up a disporportionately large component of the scammers group). Claiming depreciation was not a scam, but there is now an there will be even greater incentive to treat building assets as fitout.

The Budget will not stem the hardcore abusers, nothing will, but I agree the changes are not enough to make proeprty investment any less attractive as a long-term investment.

Anonymous said...

Well, the Nats have allocated extra money to the IRD to target the hardcore scammers. It won't deter them, but it might catch them!

Any fool can see that buildings go up in value, not down. Show me a single house from 20 years ago that is not worth far more today, even a run-down shed. My old car, on the other hand...

The point is, that in the examples given, the property investor is still making a ship load of money. Instead of 100 grand they get 90 grand a year - oh, boo hoo, how sad. Still looks like a pretty good deal to me.

Property is still the only investment in NZ. Shares are a slow way to lose wealth, as Telecom our market leader continually shows. As for Finance companies, might as well just flush your cash down the dunny. And Kiwi Saver is the next big disaster waiting to happen. Mark my words.

Unknown said...

Sadly the above statement "Property is still the only investment in New Zealand" is probably too true. In terms of return on capital it is a no brainer.
Of course what none of the anti property people seem to want to understand is that property is the one investment that you can use leverage. That is it's main attraction.
For us little people it is the one way we can honestly have a go a becoming secure. Filling shelves at night was never going to get me any degree of independence. And I make more money from my bank deposits nowadays than I do from the shares I have bought over the years. So much for diversification...

Anonymous said...

Please pause before you advise a person to sell their rental investment.Consider where could they previously have put the funds from the sale .
Maybe Strategic Finance , Blue Chip Investments , Hanover Finance, Dominion Finance or struggling South Canterbury Finance .

No matter what a government may take from a university educated advisor who lacks the knowledge of life , try sheltering your family or assisting a homeless family under an investment prospectus .

Anonymous said...

The only issue the government needed to sort in this budget was government spending. This budget has fooled many people into thinking they will be better off!!! Fools beware the first grab is the ETS, then the GST tax grab and of course for property investors next year, no depreciation. Sure some less personal tax to pay, but again middle income N.Z.ers will be paying more than there share. As for property, have to wait and see there as when we head out of recession, rents and values will rise dramatically. Ironically Australians have as much a love affair with property as NZers at 60% as opposed to NZers at 74%. Time will tell

Anonymous said...

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