Rental property, investment and trading are a hot topic at the moment.
With new rules in place, Inland Revenue is looking more closely than ever at the sector to make sure that everyone is paying their fair share of tax. But for the average property investor, remaining compliant can seem daunting. There are so many records that need to be kept, files to be attended to and accountants to be wrangled. Here are a few common mistakes I see, and some tips on avoiding them.
I make a loss, not a profit so I don't need to file a return: You might be surprised at how many people think that keeping on top of tax returns is such a hassle that they might as well not bother at all. Some people seem to think that they'd be doing the IRD a favour by not declaring any losses they might make on an investment from a rental property. If the loss is small then some think it's an immaterial refund anyway, so no one will mind if they don't declare it because it's costing IRD in time and money. The danger with this is that as the mortgage comes down over the years at some point it will make a profit, and that means tax to pay. Also why would you not want a tax refund? A $500 refund may not sound like much but over 10 years that's $5000. And remember: If you're renting a house you're obliged to file a return whether it's a loss or profit.
I don't draw any money from the rental bank account so I don't have to pay tax: Profit is calculated by adding the rent income and deducting expenses for that property such as insurance, rates, interest, repairs and maintenance, bank fees and other associated costs. Tax is calculated on the profit that you make from the rental and is not dependent on any withdrawals you make from the account. It doesn't matter whether you're lining your own pockets or leaving the money tucked up securely in a bank account. A lot of people think they only pay tax on money drawn from a business or bank account - that's just not true.
My rental is not making a profit because after I pay my mortgage there's no money left: The largest payments you'll make for a rental is likely to be the mortgage repayments. Mortgage repayments consist of interest and principal repayments unless you've decided on interest only. The interest is tax deductible, the principal repayment is not but both will come out of your bank account. This is best illustrated by an example. On a $400,000 loan at 5 per cent over 20 years in year one you'll pay $31,678 out of your account. The interest is $19,729 of that amount and the principal is $11,949. Only the $19,729 interest you can claim against your rent income.