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Close the loopholes

Written By: - Date published: 11:30 am, September 14th, 2009 - 30 comments
Categories: housing, labour - Tags:

I am heartened that Phil Goff is trying to work with the Government to address over-investment in residential property. However, I think a capital gains tax is the wrong way to go about it.

In my view, the rush to get on the rental property bandwagon is the single biggest problem facing the New Zealand economy at the moment. It is the single biggest failing of the last Labour government that they never even tried to do anything about it. It is shameful that housing, a basic human need, become so grossly unaffordable under a left-wing government. The perceived security in property has led to serious under-investment in business and a spiralling national debt problem.

I’m glad Phil is trying at last to redress this but a capital gains tax is not the most effective solution. Most residential property investment falls into the category of rental properties, rather than flipping. Capital gains tax would target flippers, who buy a house, do some minor alterations and sell it on for capital gain.

Whatever solution the government comes up with needs to target rental properties, where the weekly cashflow from rent is the main attraction and capital gain is more of a bonus after a long period of ownership.

My preferred option is to remove the ability to use losses on rental properties to reduce the investor’s tax bill. This was floated by Dr Cullen before the election, but sadly never implemented.

Most rental properties in New Zealand are negatively geared due to high house prices. That means that the rent doesn’t cover the expenses, so the investor loses money. There’s no sane reason to do that, except for the fact that our very generous tax laws allow them to use those losses to pay less tax on their incomes.

There’s no reason why our tax system should subsidise people for this type of activity. Rental property should be treated the same as any other form of investment you can’t use losses on the sharemarket or in finance companies to reduce your tax bill.

This tax loophole is the reason I don’t think a land tax would work. A land tax would simply add to the costs of running a property and if you’re already making a tax-deductible loss, it’s not going to make much impact.

Fixing this loophole would be extremely unpopular. It would lead to a price crash as investors sold out and demand dwindled. Property investors, banks and the real estate industry would be furious at the dramatic effect on their livelihoods. In contrast, a capital gains tax would have a much more muted effect, and Key could probably sell it.

But for New Zealand to get back on track, there needs to be pain. Banks have to learn to lend to business again, investors have to learn to invest in the productive sector again. They’re not going to give up the love affair with property unless they absolutely have to.

The aim should not be to drive every single landlord out of the renting business. It should be to achieve a balance that New Zealand currently does not have. To make property just one option amongst many for investors, and to make owning a home an option again for young New Zealanders.

Blue

30 comments on “Close the loopholes ”

  1. wtl 1

    But if an investor is negatively geared, obviously they are trying to make money off a capital gain and therefore will be hit by a CGT.

    • ieuan 1.1

      Only when they sell.

      Also it would be easy to avoid the tax if you make the property your ‘primary residence’ before you sell it.

      I know there would be rules around this but if you have had the property for 10-20 years then the CGT would be tens of thousands and moving in for 6 months (or whatever time period is required) would be a good option.

  2. ieuan 2

    Yep totally agree.

    Any changes could be phased in first by giving 1-2 years notice and then gradually reducing the tax benefit until it is zero. That might help prevent too much of a shock to the housing market.

    I heard on Radio Live that the cost to the government of this tax benefit is something like $2.3 billion and this is a massive increase from last year when it cost the government $700m, has anyone got the figures?

  3. Samuel Konkin 3

    This is silly.

    Income from rental property is taxed. If losses are made they can be offset against other income. They key thing is…losses are made! That means either they were relying on the capital gain, or they were committing tax avoidance by generating fake expenses.

    A CGT deals with one; general anti avoidance provisions deal with the other.

  4. Guest Post:

    You called someone who buys a house and makes adjustments to it, then sells it for a profit, “A Flipper”

    I call someone who buys a house and then invests their TIME and MONEY and BLOOD SWEAT AND TEARS, into the house, a hard working kiwi, and they deserve to sell it off for a profit.

    PS: When you used words “Minor alterations” what point were you trying to make?

    • ghostwhowalksnz 4.1

      Australia had a requirement that the property be owned for a year before it be classed as investment over speculative. There were special circumstances for when people had to relocate etc.
      Plus most states have ‘land tax’ which is a yearly tax based on the value of the property, excludes all but the most highly priced homes

    • Chris 4.2

      They shouldn’t be rewarded because it should end up being a waste of time. They sould invest their time, blood, sweat, tears in somehting actually productive

  5. Terry 5

    “It is shameful that housing, a basic human need, become so grossly unaffordable under a left-wing government.”

    Agree but the reason was probably that the fifth Labour government wasn’t a left-wing government. Duh.

  6. Pat 6

    A big factor in the popularity of rental properties, was the Banks made finance so easy. At the height a few years ago you could borrow up to 100% for an investment property, without including your home as security. And with Lo Doc loans you could buy a rental property without proving your income. It made it easy for the Blue Chips of this world to get any man and his dog a rental property.

    But those days are gone and the maximum is back to 70% or 80%, and much less for apartments. So the heat is well and truly gone out of this market and can’t come back unless the Banks let it.

    Depending on its rules, a retrospective CGT would not only be unpopular, but probably unfair, particularly on those that were building a portfolio for retirement, with a view to selling down some to repay the debt and keeping the rest for income.

    A CGT implemented for all future investment has probably missed the boat, since getting finance and equity to build a decent portfolio is going to prove very difficult from now on.

    The property “traders” are meant to be paying tax anyway. This lot are finding competitive finance options very thin on the ground. A trader is easy for the Banks to spot, and they are on the bottom rung when it comes to getting loans. Not least because there is no profit for a Bank in a loan that is repaid within two years.

  7. Samuel Konkin 7

    The other alternative is that genuine losses were made – but that is not something you want to stop per se. I meant that the only policy-relevant reasons why you;d make losses is because of the absence of a CGT, or a failure of the GAAP.

  8. burt 8

    Whatever solution the government comes up with needs to target rental properties, where the weekly cashflow from rent is the main attraction and capital gain is more of a bonus after a long period of ownership.

    How out of touch is that – all most as out of touch as Labour… No wonder they don’t want to do what is unpopular because how would they get back into power doing that…..

  9. Ianmac 9

    What would happen if investment/rental properties were dropped by many landlords? The tenants have to live somewhere and someone has to own the house. There could be a housing shambles????

  10. RedLogix 10

    Rental property should be treated the same as any other form of investment you can’t use losses on the sharemarket or in finance companies to reduce your tax bill.

    You fail to make the basic distinction between a capital gain/loss and operating expenses.

    In fact rental investments are treated for tax purposes exactly the same as any other business.

    Kathyrn Ryan on NatRad this morning had an excellent interview with John Sherwin (Chairman of the Tax Review Committee) who was very sceptical of the effectiveness of CGT’s (for much the same reasons I’ve outlined many times before.) I really recommend a listen.

    Personally I think Goff has made a very poor tactical move here. By making the first big public move on CGT, he’s going to hang himself and Labour with what will prove and exceedingly unpopular and ultimately ineffective measure.

    • Pat 10.1

      “Personally I think Goff has made a very poor tactical move here.”

      Agreed. And note Key moved quickly this morning on Breakfast to state his personal position. Not only has he rejected Goff’s olive leaf, he has left him sitting out on the limb.

      Without Key’s support the issue is dead, because CGT as an election policy is un-campainable.

    • Lanthanide 10.2

      Actually Goff has just said he’d work with the government on it, not that he would do it himself.

      This gives National the backbone to go ahead and do what they probably want to do (earlier in the year Key and English said flat-out ‘no’ to CGT, and now they are letting the working group investigate further), but didn’t want to risk their position for. Now they can go ahead and do it, because the public have no alternative party who will oppose them.

      • George.com 10.2.1

        A couple of years back Cullen raised the issue of a CGT. Bill English dismissed the idea and nothing further was heard. What Goff has done is open the door for National to explore the idea further if they want. That is, the opposite of what English did.

        Interestingly English said that the RBA had the necessary tools to deal with the property market. I wonder if he thinks that now?

    • ieuan 10.3

      ‘In fact rental investments are treated for tax purposes exactly the same as any other business.’

      Rubbish, if I make a loss in my business but still pay myself an income I still have to pay tax at the normal PAYE levels for that income I can’t offset any of the business loss.

      Also if I had two incomes, one from, say an investment, and the other from a business, again I can’t use any losses from the business to offset my tax liability from the other income.

      A business can carry over a loss but it can’t be transfered to offset income tax from other sources. In that regard the tax benefit for a negatively geared investment property is unique.

      • RedLogix 10.3.1

        A business can carry over a loss but it can’t be transfered to offset income tax from other sources. In that regard the tax benefit for a negatively geared investment property is unique.

        That is only superficially true. Where the owner of the business and the taxpayer on income from another source (eg a salary) is one and the same person (what is technically called ‘tightly held’)… then the tax position of the business and the salary earner is effectively one and the same.

        If losses in the rental business were ring-fenced, then all that would happen is that the accumulated loss would simply be unwound at some point in the future, and any refunds claimed as a lump sum at the end of the tax year. In other words the tax offsets would eventually make their way back to the owner… just delayed into the future.

        The whole point of LAQC’s which is what you are talking about, is that they do not confer a unique tax benefit, rather they are a cash flow smoothing mechanism. Instead of delaying the offsets… the owner simply pays less tax on their other PAYE income as it is earned. The total tax paid over time is exactly the same.

        The downside of scrapping LAQC’s is that immediately most landlords would face an immediate cash flow crisis… and would mostly likely raise rents by 20-30% accross the board in order to stay in business.

        The other two factors no-one ever mentions are:

        1. Any depreciation claimed will have to be repaid if and when the property is sold.

        2. Being zero rated for GST, most rental businesses are not GST registered and pay the full whack of GST on all their inputs… most significant when building new units or purchasing land.

    • jagilby 10.4

      Who’s John Sherwin?

      You mean John Shewan (chairman of PwC),

      • RedLogix 10.4.1

        Yeah, I’m guilty of spelling it as I heard it.

        • jagilby 10.4.1.1

          I agree with absolutely everything Shewan said, problem is could you imagine the shreiks from patrons of this blog (yourself perhaps included) if we moved to the broad base championed by Shewan and a flat tax system emerged with the highest rate of 20%-25%?

          The headlines would be “Key gives the [insert rich/elite/old white men/banking mates] a tax break”. Then what happens? The fear for many would be that any broadening and flattening of the tax base would lead to a Labour government coming in and “tinkering” (i.e. reintroducing higher marginal rates, hiking capital gains rates) in order to increase spending beyond what is sustainable. Only difference is this time they would have a broader base to kick off from… you may disagree but that is the reality of where the fear originates – if Labour wants to get “back in touch” then there is a good starting point.

          I think Shewan touched on that and it is a very very precient point…. you want a CGT, you have to play ball long term on it. Don’t use it as a football. I think that has to be absolutely enshrined in law. Then you may find an equitable position may be able to be sold…. anything less and you can talk about NACT secret agendas but as far as the business/right’s world is concerned tax rates and spending is at the top of what they see as the left’s agenda.

          I’d agree with a tax free threshhold somewhere in there ($10k perhaps) – again that perhaps isn’t academically distortion free but I can understand some people are more vulnerable even in a flat tax environment.

          In the end the tax system (and I know this is really somewhat of an oxymoron) has to become free of politics. It has to be stripped down, shaped up and set in concrete. A flat system is understandable and would be much harder to manipulate.

  11. Clarke 11

    For all the fact that I think a CGT would be a useful way of leveling the playing field, it still won’t change the underlying investment behaviour of Kiwis.

    Redirecting investment out of residential property presupposes that there is an alternative vehicle available that has a similar risk/reward mixture. This clearly isn’t the case in NZ – there are far too many cowboys (and far too little regulation) in both the stock market and the finance markets. Given the huge string of losses from Feltex to Bridgecorp and all their fellow travelers, you’d need your head read to put money into shares and debentures. Most Kiwis know this.

    If Bollard and co want less investment in residential investment, then cleaning up the unregulated wild west aspects of our equity and financial markets would be a smarter idea than a CGT.

  12. Blue 12

    ieuan, there is a link discussing what it costs the government here: http://www.interest.co.nz/ratesblog/index.php/2009/09/08/laqc-losses-tripled-to-nz23-billion-between-2003-and-2008/

    Brett Dale, my reference to ‘minor alterations’ was a reference to the fact that to make money by ‘flipping’ (which I don’t consider a perjorative term) you can’t over-capitalise by doing too much work on the place. I was not implying that it isn’t hard work.

    Ianmac, I specifically said that I do not want all landlords driven out of business. There needs to be some, but ideally more people would have the opportunity to buy rather than rent, reducing the number of privately-held rental properties needed.

    RedLogix, I do understand your point. If you create a company to house your investments you can claim the same benefits businesses are entitled to. In practice in New Zealand, this is mainly used by property investors rather than sharemarket or other investors.

    • ieuan 12.1

      Thanks Blue, the $2.3 billion I mentioned was over a 5 year period and not a one year period as I thought.

  13. Dave 13

    I submitted this to another site with a similar discussion.

    The Price Waterhouse spokesman (John Sherwin?) who is also on the body that is to report on tax ideas suggests a land tax .
    Question. Why not a tax on the capital value?
    The benefit also includes paying a tax on the borrowed part of the asset – a tax added to the interest.
    So a 1% tax on a $1m property would be $10k even if there is $900k borrowing and only $100k net asset.
    No do not include personal home BUT why not do it by imposing such a tax but having a threshhold below which there is no tax – say $500k. If you then want to live in a $2m property you pay the tax on the extra.

    Any thoughts?

  14. mikesh 14

    The logic seems faulty. A landlord who loses $1,000 (say) and who is on a tax rate of (say) 20%, recovers only $200 of his loss. The remaining $800 portion can only be justified by the capital gain he expects to make when he sells the property.. However, a land tax would probably be better than a capital gains tax because it would tend to discourage increases in land values, and of course it would be levied annually and not just when the property is sold.

  15. JD 15

    “but ideally more people would have the opportunity to buy rather than rent, reducing the number of privately-held rental properties needed.”

    Some people actually prefer to rent depending at what stage they are in their lives. If I was 18 again it would be an ideal situation for me to go flatting with others. About 4 years ago in Wellington there was a massive shortage in rental properties with uni students attempting to outbid each other. How is this situation ideal?

    “Given the huge string of losses from Feltex to Bridgecorp and all their fellow travelers, you’d need your head read to put money into shares and debentures.”

    Agreed. Give the losses I’m nursing on my portfolio I’ve learned my lesson. Thankfully most of my families wealth was in investment property so we avoid a massive destruction of wealth that has left many retirees and babyboomers looking poverty in the face for the rest of their lives.

    Didn’t Helen Clark have several investment properties too? She was no mug. Given the inflationary ‘quantitive easing’ policies of govnt around the world I’d say the run will continue.

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