Andrew Bruce: Property investors are tax disadvantaged

Property investors are disadvantaged by the NZ tax system, says Andrew Bruce. Photo / Michael Craig
Property investors are disadvantaged by the NZ tax system, says Andrew Bruce. Photo / Michael Craig

I recently wrote an article titled 'Why are house prices so high'. The key messages can be summarised as:

• If the costs to develop a house or section rise/are high, then the price of property will have to increase to cover these costs.

• This can restrict the supply until such time as price increases make it economically viable to develop more properties.

This is the basics of supply and demand.

Leading on from this is another misconception: people still believe property investors are tax advantaged and that investors, developers, traders and speculators aren't taxed.

Before I cover the tax issues we need to understand the difference from a tax perceptive between a:

• property investor

• property speculator/trader and

• property developer

A property investor, quite often referred to as a 'buy and hold' investor, purchases a property with a view to the income stream (rental) the property provides. This is a long term strategy. Their intention is to hold onto the property.

A speculator or trader is a person who buys a property with an intention of selling at a higher price sometime in the future.

A developer is a person who adds value to properties or creates new properties through subdivision or building. Once again their intention is to sell at a higher price than the costs associated with developing the property.

A property investor is taxed on the income their portfolio generates. At the start of most investors careers the properties they purchase may not always be positively cash flowed. However, through astute purchasing, good management and regular maintenance over time the aim is for these properties to generate a positive cash flow, which is taxable. This is very similar to many start-up companies as it's not always possible to generate a profit from day one.

A speculator, trader or developer who sells their property is liable for tax as their intention is to generate a capital gain through either adding value to the property, or speculating on purchasing low and selling high.

Auckland Property Investors Assn president Andrew Bruce.
Auckland Property Investors Assn president Andrew Bruce.

Assuming these purchases are made in a company the profits are taxed at 43 per cent (being 15 per cent GST and 28 per cent company tax rate). This is no different to any other business that sells a product, the only difference in the above example is the commodity is property. For this reason when commentators or public figures say speculators, traders or developers are not taxed on capital gains is clearly incorrect.

If tax isn't paid when the intention is to buy and sell for a capital gain then it is tax evasion i.e. illegal. It is like a person going into a bike shop and stealing a bike. While you can correctly say the person who stole the bike obtained it for free, it is against the law.

In 2007 the then Deputy Commissioner of Inland Revenue Department, Robin Oliver was
asked by a Government Select Committee if there were tax advantages for investments in
rental housing.

Mr Oliver's response was '...the short answer is there is none. Rules about expenses for deducting costs such as interest, upkeep and maintenance, as well as paying tax on income were the same for investments in shares or anything else. In fact under the housing case, the capital gains boundary is brought back a bit'.

Since then in the May 2010 budget the Government withdrew depreciation on buildings as a deductible expense. For this reason property investors are now tax disadvantaged when compared to other forms of investments such as companies which are still able to claim depreciation on the assets used for their business as a tax deductible expense.

The other misconception that has also been portrayed about property investors is we are not net tax payers. This was raised by the Tax Working Group in 2009.

The New Zealand Property Investors Association (NZPIF) recently obtained new information as a result of an Official Information Act request. This proved that over the past 33 years property investors have been net tax payers, with the exception of 2008 and 2009 when interest rates were very high.

As can be seen by the graph below, for the financial year ended 31 March 2013 property investors paid tax on a net rental of $1.476 billion.

Whatever your strategy in property, the profits are taxable and due to the removal of depreciation on buildings as a tax deductible expense, property investment is now at a tax disadvantage when compared to other investment classes such as companies.

Using a sporting analogy to conclude, property investment is the equivalent of test cricket, where a longer term strategy is implemented and reward is based on patience, perseverance and ongoing refinement of your skills and knowledge. As opposed to property speculators, traders or developers which is more akin to a 20/20 or a one day match where the rewards or losses occur quicker but the risks are greater.

- NZ Herald

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