Politics and Property tax here we go again. From Withers Tsang September 2017

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September 2017
Withers Tsang & Co Ltd.
Politics and Property tax here we go again
Dear Clients

Politics and Property, both start with P and have eight letters but why do they get so joined at the hip ?

Many of our clients at Withers Tsang are property investors, and our specialist topic is navigating the tax laws that affect our clients.

This election campaign though has been challenging. On the one hand we have the government effectively offering the status quo with respect to tax on property but we have the opposition offering significant change.

The only problem is, they won’t tell us exactly what those changes might be.

This newsletter seeks to cast some light on the proposed changes that are most likely to be implemented if we have a change in government. The commentary is my own thoughts on what the changes could mean and how they might impact individuals.

So what are the most likely changes under labour ?

  1. Ring Fencing tax Losses. This proposal is in my view the most likely change option that has received the least air time during the campaign. Ring Fencing of tax losses has certainly been labour party tax policy under previous leaders and it was one of the options considered but rejected when the existing government looked at changes to property tax policy that lead to the removal of depreciation on buildings. Ring fencing is also already a feature of losses on mixed use assets like holiday homes, this crept back in under National when they tightened the rules for rented holiday homes. Ring fencing simply prevents legitimate cash losses from a rental property from being offset against other personal income to derive a tax refund. Typically the losses must be tracked into the future and carried forward to be offset only when and if the properties can produce a taxable profit. Ring fencing then artificially inflates the taxable income one must declare by denying an offset for the activity that causes a loss. Ring fencing would therefore put those that are negatively geared on their properties under significant extra pressure but would have virtually no impact on property investors that are profitable. Is it fair that within the property investment community those that are less profitable pay more tax but those that are profitable pay nothing more ?The number of property investors though that would be directly impacted by ring fencing is much smaller now than the days when losses were higher due to depreciation. Lower interest rates have also meant that those with some equity in their investments are typically profitable and paying tax. Consider though the plight of investors hit hard by an adverse event, like discovering that a property is leaky and requiring huge remedial costs or discovering that a tenant has smoked P and a significant remediation is required before the property can be re let. These events almost always lead investors to record losses in years where money is spent to address repairs to properties. Ring fencing these losses rather than allowing them to be utilized immediately to reduce a tax burden strikes me as particularly harsh.
  2. Increasing the bright line test from 2 years to 5. No doubt here, this measure has been announced and is definitely on its way under labour. This measure is capital gains tax by another name, but, its capital gains tax at the income tax rate of 33% ! Previous proposals to introduce a standalone capital gains have not suggested the rate of tax would be set at the income tax level so this one would have a real impact. The bright line test legislation is already in law so it would be the easiest thing in the world to simply set a date where the test moved from 2 years to 5. Now the bright line test applies to all residential land including vacant land with an exclusion for the family home and the exclusion of sales of inherited land. So if this change comes in, effectively any gain on disposal becomes taxable at the full income tax rate if the property is not retained for 5 years. The main impact of pushing the bright line test out to 5 years is that most investors would simply mark their diary 5 years from acquisition and not contemplate a sale until the tax could be avoided. This would of course limit the supply of rental properties coming to the market, the very same houses that are often purchased by first home buyers. A limit on supply, as we have seen, always results in price increases. This also sets up a situation where genuine investors, those who invest for rental return, don’t take decisions to sell low yielding property simply because they are focused on avoiding the bright line tax. If these properties did come to market and investors could increase their profitability as a result, more taxes are then collected by the government on the higher net rental incomes. The bright line test therefore creates an artificial distortion in an otherwise free market that could have unintended consequences. Consider also that the Brightline test only applies to residential property not commercial property. This may well suit a political agenda aimed at helping first home buyers into property but it also creates a significant distortion between the tax impacts felt by residential investors when compared to their commercial cousins.
  3. Capital Gains tax – Looks also to be likely this time round. It’s the old chestnut and again no detail is being offered on how it would work or what it would be applied to except that the family home would be excluded. Whether capital gains on the family bach, farm or business though would be included is anyone’s guess. Something that should be understood about capital against tax though is that it would be unlikely to be retrospectively applied. To introduce a capital gains tax step one is to establish a market value for all properties at the date the tax is introduced. This in itself would be no mean feat but the tax would operate to tax gains relative to the value at this date in time. The tax would not be applied to historic gains on properties that are long held. The opposition has not ruled out applying capital gains tax to inherited property which creates a further contrast with the bright line test. The irony of introducing a capital gains tax now though is that the property market is now flat to declining. It would therefore be a very expensive tax to introduce that would be unlikely to actually yield much revenue from the property sector until such time as the market turns around. In comparison with the ease with which the bright line test could be extended the problems with a capital gains tax makes it look like a real dinosaur by comparison. But the oppositions political view does seem to be that the tax is needed to arrest growth in the housing market so you would seemingly have a tax being introduced, that if it works as intended to reduce property values, actually won’t function to increase government revenue. How ironic.
  4. Land tax – A blast from the past, back to the future, however you like to term it, land tax was a hated wealth tax that we enjoyed back in the early nineties. It was imposed at a rate of 2% annually on the government valuation of land owned other than ones family home. A straight out tax on wealth held in property regardless of the income that the land produced and in addition to income tax on the rental income. The opposition have ruled out a land tax being applied to a personal home but have not ruled this type of wealth tax out altogether. It was a compliance nightmare as it required the annual filing of stand-alone land tax returns. My days as a junior accounting clerk tasked with completing these hated returns sends a particular cold shiver up my spine at the thought they could be back. Let’s hope not.
  5. Whilst not tax policy, the opposition also has big plans to strengthen tenant rights under the residential tenancies act. The planned changes include:
    – Extending notice periods from 42 to 90 days
    – Abolishing no cause terminations
    – Restricting rent increases from 6 monthly to yearly
    – Forcing landlords to include a formulae in tenancy agreements to set rent increases. This is very worrying when you consider that the bundle of policies seems set to drive up rental costs to tenants.
    – Abolishing letting fees
    – Passing the Healthy Homes bill that will impose minimum standards on rental housing and force landlords to make upgrades.
    Landlords though are promised nothing more than extra resourcing of the tenancies tribunal so that they can have their grievances dealt with more efficiently which would seem like something of a two edged sword when the RTA is already so tenant right dominant. Nothing substantial at all there to assist landlords to deal with the scourge of the P problem or coping with leaky building problems.

And there you have it, some thoughts  on the measures that we may be facing in the property sector if we have a change in government.

All will be revealed after September 23

Withers Tsang & Co Ltd.
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