Money Matters: Investment not safe as houses

By MARY HOLM

Q. In an attempt to secure my financial future, I have bought dwellings on Waiheke, one of which I intend to live in when I retire.

Waiheke values continue to rise, and I fervently believe they will outstrip Auckland City in years to come.

However, finance is not one of my strong points, so I sat down and took stock of my position.

What I discovered alarmed me. I found that last year my incomings from rent were $46,000 bifshort of my outgoings (this balance coming, of course, from my own salary).

I received a tax rebate of $11,000, which still leaves me with a deficit of $35,000.

My projected deficit for this financial year (mortgage, rates, insurance to be paid first) will be an estimated $34,000. I have no idea how much I will get back from the IRD.

Even though Waiheke values are rising, my properties would not have increased by as much as the thousands extra I've taken out of my salary/savings already. I am heavily mortgaged, but can manage payments without hardship.

Is this normal practice which has some benefit I have not quite grasped, or am I just incredibly stupid, and lacking in any fundamental understanding of financial matters?

If it is the latter, shouldn't my accountant or bank manager have told me so?


A. Clearly, you're not stupid. You have looked at your situation, found it worrying and decided to do something about it. That is good thinking.

I must say, though, that you have got good cause to be worried.

When I first read your letter, I double-checked to make sure you had not accidentally added an extra zero to get $46,000 rather than $4600.

I suspect that year-round rentals on Waiheke are not all that high, because lots of people would want to rent out their baches. So that will not help your situation.

On the plus side, the accountant points out that part of your mortgage payments will be repayments of principal. Your mortgage documents should show you how much the amount you owe dropped last year. To that extent, you gained equity in your properties, so you did not lose that money.

But your other expenses - mortgage interest, insurance, rates and so on - are pure costs.

Keep in mind, too, that if you are claiming depreciation on your tax return - which most people with rental property do - it is highly likely that that money will be clawed back when you sell.

When you are looking at your shortfall, then, do not include repayments of principal in your outgoings. But do add back depreciation to the shortfall.

Once you have that shortfall number, you are right to compare it against appreciation on your properties. Even if the two numbers were about equal, though, that is not good enough.

You should allow for the fact that you won't get the appreciation until you sell the properties, which may be some years down the track.

A dollar now is worth much more than a dollar later. You can earn compounding interest on it in the meantime.

As a rule of thumb, if you pay out $10,000 now and expect to get $15,000 in ten years, you are getting a return of about 4 per cent. If you get $20,000 in 10 years, your return is about 7 per cent.

To add to your worries, you may be overly confident that Waiheke will turn out to be a brilliant investment.

I am not saying it won't be. I do not know; no one does. But, to the extent that people in general expect Waiheke values to rise faster than elsewhere, that will already be reflected in prices.

And you have got pretty much all your savings in one type of asset, and in one place. That is scarily undiversified.

So what to do about it? I would sell most of the properties, perhaps all but the one you plan to retire to. If there is one that brings in higher rental relative to its price, you might keep that, too.

There is no panic. You could put the properties on the market at reasonably high prices, in the hope at least one will go fairly fast. That will free money to slash mortgages on the others.

Once you have got out of your bind, consider investing regularly in a share fund. If you put in even half what you have been paying to keep your properties going, you will build up a sizeable retirement fund in no time.

As for your question about your accountant and bank manager, obviously it would have been good if they had talked things through with you.

But, unless you asked them for advice, I don't think you can blame them for not volunteering it.

Q. I am writing about a recent column in which you discuss depreciation on a rental property.

Firstly, you imply that claiming depreciation on a rental property is optional, yet last year my lawyer's accountant advised me that new rules now made it mandatory to claim such depreciation. Could you kindly advise if the rules have changed.

Or, if depreciation has been claimed for several years, can I opt to not claim it in the future?

Secondly, when clawback action is taken, do they claw back the actual amount claimed for depreciation, or do they assess the clawback (at say 33%) on the accumulated depreciation?


A. Okay, okay. Depreciation is one of those topics - like annuities, rest home subsidies and British pensions - that do not die. After one Q&A, I get lots more letters on it, till everyone gets bored witless.

But enough of you have written about whether depreciation is optional that I better tackle it.

The deal is this, according to Inland Revenue: When you first start renting out a property, you can "elect" not to claim depreciation ever. But once you have started claiming it, you cannot stop.

In other words, you decide one way or the other at the beginning, and then stick with that decision.

It sounds as if your lawyer's accountant is out of date, or there has been a misunderstanding. Yes, the rules have changed, but in the opposite direction. Before September 1997 it was compulsory to deduct depreciation.

I suggest she/he gets a copy of the June 1998 version of IR 264, Inland Revenue's booklet on rental income. You might want to get one too.

You can get the booklet posted to you by phoning 0800 257 773. Have your IRD number handy and select "other stationery items" when that is given as an option.

Or you can go to IRDs web site. Click on publications, then General Information, and then scroll down to Rental Income.

Lets turn to your second question, on the clawback. If you sell a rental property for more than you paid for it [dash] after subtracting from your sale price costs such as commission and advertising [dash] add all the depreciation You have claimed over the years to your taxable income on your tax return.

That means that if you are in the 33 percent tax bracket, you will pay tax of 33 percent of your total depreciation. Similarly for the other brackets.

If you sell the property for less than what you paid, calculate your adjusted tax value, which is your purchase price minus all depreciation.

If the sale price (minus selling costs) is larger than that, include the difference in your taxable income. If not, there is no clawback of depreciation. that is because the property did actually depreciate by the amount claimed, or more.

(These rules apply to buildings only. There are different rules for other assets.)

While were at it, another reader asked "If you held a property until it was fully depreciated, do you then have to have it revalued?

Firstly, its highly unlikely to happen. Generally it takes 50 years or more to depreciate the property down to zero.

Once You have done that, that would be the end of any depreciation. And you would face a monstrous clawback when you sell!

In case you are thinking that a property could be passed down within a family for more than 50 years, the IRD notes in IR 264, "If the property has been inherited, the cost price for depreciation is nil, because there was no cost to the current owner." This means the person who inherits could not claim any depreciation.

Q. Regarding the couple who have $400,000 saved plus a house and want to go beachcombing (Money Matters, April 29): that is a natural reaction after reaching 40 and losing one's job.

But they should wake up to the fact that they stand at the crossroads.

A local investment magazine publishes regularly the performance results of NZ managed investments (unit trusts, insurance bonds, superannuation funds etc.). Recently, I calculated the average return of the 133 that had seven-year results available to have compounded returns, after tax and fees, of 6.72 per cent a year (highest 18.63 per cent, lowest 0.70 per cent).

If the correspondent picked a spread that gave him, say, 6.5 per cent after tax and fees, leaving the fund to grow, he could retire at age 50 (after 10 years) with capital of more than $750,000, or at age 55 with more than $1 million.

All he needs is a minimal job that pays the grocer and the butcher and for repairs to the roof over his head and allows his capital to grow in an investment.

At 40, I too often thought longingly of a beachcombers life, but with four children and a non-earning wife I knew it was a pipe dream. (I say non-earning, not non-working, as she worked harder than I did raising four kids.)

I also knew that the boredom of beachcombing would kill me inside six months.

We lived on my salary, and though we had considerably less than $400,000 at age 40 we cultivated what we had and I retired at 58.


A. You might be a bit too optimistic. But you make a good point.

In my response to the original letter, one of my suggestions was that the couple work on for a while, so they could add to their savings.

I didn't go into how much their savings might grow in the meantime - and I should have. Thanks for doing it for me.

If I had done it, though, I would have used not only an after-tax, after-fees return, but a return adjusted for inflation.

As your numbers stand, without that adjustment, they could be misleading.

Even if inflation stays at 2 per cent, over 10 years that reduces the value of $750,000 to $615,000.

If (with apologies to Don Brash for even suggesting it) inflation were 4 per cent, the $750,000 would be worth just over $500,000.

As for the $1 million, 15 years of inflation at 2 per cent would slash its worth to less than $750,000. At 4 per cent, it would drop to about $550,000.

Also, it might be optimistic to use your 6.5 per cent return before inflation. You may have been to seminars where they blithely use 10 per cent to calculate the growth of savings. Usually, the speaker is trying to sell investments. He (rarely she) says something like, "Those returns might be higher than you will get."

But they still keep using them. Funny, that.

Let's turn to an unbiased source. Your Retirement Action Planner, a booklet given out by The Office of the Retirement Commissioner, uses 3.2 per cent for a lower-risk saver (after taxes and fees and before inflation), and 4.2 per cent for a higher-risk one.

Given that our would-be beachcombers were thinking of putting their savings into term deposits, we can probably assume that they would not be keen on taking too much risk. So 3.2 per cent may be a good starting point.

Having said all this, the couple's savings may grow even faster than you predict. In any case, as long as they do not invest stupidly, their money will grow faster than inflation.


* Got a question about money? Send it to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@journalist.com. Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number in case we need more information. We cannot answer all questions or correspond directly with readers.

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