Last week Labour announced further measures to crack down on property speculators. Their latest measure is to close the "loop-hole" on negative gearing, and is the third policy statement targeting residential property investors. The other two previously announced policies would ban overseas investors buying existing homes, and extend the capital gains tax (bright-line test) on rental houses from two years to five.
To recap, negative gearing is where an investor makes a loss from their investment, and offsets that loss against other income derived from another source. The effect is to reduce their taxable income, and therefore the amount of tax they pay (based on their marginal tax rate).
For example, if a property is rented for say $20,000 a year but the expenses (typically interest, rates, insurance and repairs) total $25,000; then the $5,000 loss could be offset against their other income. So if they earn say $50,000 from wages or business income, then they would pay tax on $45,000. In this case their tax bill would fall by $1,125 from $8,020 to $6,895 which, in effect, reduces the loss from the rental from $5,000 to $3,875. According to Labour, this "loop-hole" is causing property prices to rise and making houses less affordable for kiwi families.
Although this is described as a "loop-hole", it is not a loop-hole at all. For example, it's not uncommon for businesses to spend up large on marketing during their start up phase and run at a loss. That loss may be offset against other income to gain, in effect, a portion of that spending back as a tax refund. Once the business is established in the marketplace and shows signs of turning a profit, the business could be sold for a tax free capital gain. The bright-line test does not apply as it only relates to residential property investors (ignoring the intention test which is another matter again). From a tax perspective, in this example the business would receive tax refunds during its start up phase, and the owners would make a tax free gain on the sale.
To disqualify property investors from doing the same, is not closing a loop-hole, it is actually creating a special tax penalty for residential property investors. Labour thinks landlords should be targeted, but then they probably would bring back the stocks to city malls and subject landlords to public humiliation and tomato throwing if they thought it would advance their political cause.
Under Labour's "ring-fence" proposal, each property would stand alone for tax purposes. Losses would have to be carried forward into future tax years to be offset against future profits should there be any. This would affect all property investors, from first time property investors who typically have to borrow heavily to get a start, to portfolio investors who typically use the equity in their portfolio to borrow 100% of their next investment.
Presumably those who own more than one rental property would have to report their annual income on a property by property basis, and pay tax on some and carry forward tax losses on others. That's an exercise that will keep accountants busy and test their creativity as they apportion interest costs between the properties.
I doubt ring-fencing would have any impact on property prices, and I doubt the additional tax revenue collected would be close to the $150m a year estimated by Labour. The use of negative gearing has been greatly reduced in recent years since claiming depreciation on residential property was removed, and interest rates are historically low. These factors have meant many landlords are paying more tax than they did previously.
I also doubt that ring-fencing will have any significant affect on house prices. What is abundantly clear is that the latest boom in house prices is driven by demand. New Zealand's population is growing by around 1.5% a year due to high immigration. These people need to be housed.
On the supply side, a free market would react quickly to the housing demand but the market has been unable to do so because of restrictive planning laws that have added significantly to land development costs. Further aggravating housing costs is a shortage of tradies and an increase in their charge-out rates as they make hay while the sun shines. Building supply companies have also been increasing prices at a time when global construction costs have been falling (eg steel).
If Labour was serious about addressing the housing shortage it should look to these areas, but then politicians are primarily interested in the politics of winning votes, and, for Labour, that means engaging in the theatre of slaying villainous landlords.