KEY POINTS:
It is the elephant in the room of New Zealand politics. Everyone knows it, yet our leaders refuse to address it, partly because they and their generation benefited personally through the massive house price inflation it created.
I'm talking about the abuse of the tax system by property
investors that has allowed them to establish various types of trusts and loss attributing qualifying companies (LAQCs) that make losses on investment rental properties to reduce their personal income tax bills.
This was among the major reasons for the property investment frenzy of the past six years that drove house prices to unaffordable levels and has now created the conditions for a bursting of that bubble.
It wasn't always this way.
Property investors used to make a profit from rental properties. That was possible when house prices were half their current levels six years ago and interest rates were closer to 6 per cent than 9 per cent.
Then the Labour-led government imposed the 39 cent tax rate and house prices started rising. Low interest rates globally encouraged banks to raise money on wholesale money markets and lend it to property investors.
A frenzy developed. Every mum and dad in the land wanted to be a landlord, particularly a passive one.
As prices galloped higher and interest rates rose, investors began accepting ongoing losses from investment properties. The losses were offset against the regular incomes of the mums and dads.
The introduction of the 39 cent tax rate and the Government's insistence on allowing bracket creep increased the incentive to negatively gear.
Effectively, all other PAYE taxpayers were subsidising leveraged investment in a non-productive investment funded by foreign debt.
Then, if property investors were careful, they could crystallise gains without paying a capital gains tax. All they had to do was cross their fingers behind their back and tell Inland Revenue they had no intention of trading the property for profit.
I'm still amazed this has been allowed to endure. There is no sense of anger yet from PAYE investors who are subsidising speculative property investing.
Yet it continues.
The Department of the Prime Minister and Cabinet wrote a report on house prices and affordability in March. It showed landlord numbers rose more than 100,000 to 300,000 in the decade to 2006. The report estimates the $149 billion of rental property generates a tax benefit of at least $700 million for property investors, with the potential for up to $1.8b of tax benefits.
The Reserve Bank has asked the politicians to consider ring- fencing these investment property losses to remove some of the hot air pumping up the housing bubble.
But there isn't a politician addressing the issue seriously.
After a 17-month inquiry, Parliament's Commerce Committee released its report on housing affordability last week.
It was a timid affair that recommended some nudging of local government to open up more land for home building and congratulated the Government for launching a shared-equity lending programme.
National and Labour are equally guilty. So why won't our politicians address this issue? They appear afraid of the reaction from their peers in the investment property market.
That's a pity because 120 Kiwis emigrate daily to Australia. They don't have much hope of owning their own homes to raise a family. They no longer vote.
The answer is property investors must be stopped from offsetting their rental property losses against personal incomes.
Bernard Hickey is the managing editor of interest.co.nz, a website for investors and borrowers wanting free and independent news and information about interest rates, banks, finance companies and the economy.
