NZ Herald 4 November 2006

AThe New Zealand law on taxing of capital gains is indeed difficult. Your letter is full of common misunderstandings that arise from that. And that’s the fault of those who wrote the law, not you.

I don’t mean to lump long-term share holdings in with rental properties. I’ll explain why in a minute.

But firstly, your understanding of the law is not quite right in these respects:

• Money borrowed to invest in anything is not tax deductible. Only the interest you pay is deductible, and then only if it’s an expense you incur in earning taxable income.
• You’re correct that there is no capital gains tax as such. However, if your main “purpose or intention” when you buy a property, shares or anything else is to sell at a profit, the gain you make on sale is likely to be regarded as taxable income, not a gain.

I’m not advocating a new tax. I’m just suggesting that Inland Revenue enforce the current law.

That should mean that if a landlord is deducting mortgage interest paid — and I suspect that most do — they need to show that they are either earning taxable income year by year or expect to earn taxable income from the sale price when they sell.

Those who bought rental properties some years ago may well be earning taxable rent income now. The rent more than covers their mortgage interest, insurance, rates, maintenance, depreciation and other expenses.

They could probably convince Inland Revenue they bought the property to earn that rental income, rather than to make a profit on sale. When they do sell, then, their gain will generally be tax-free.

However, many landlords who have bought rentals at recent price levels are not making money. They are “negatively geared”, which means the property is operating at a cash loss and tax loss year after year, and they have to put in money from elsewhere.

Landlords often think this is good, as they can deduct the loss on their tax returns. Even after tax, though, their investment is a loser — unless they make a capital gain when they sell the property.

They must, therefore, have bought with the main intention of making such a gain. And that, I’m afraid, means that gain is taxable.

Inland Revenue should be — and perhaps is — noting every landlord who repeatedly reports losses on their property. If the property is sold at a gain, tax should be assessed on that gain. That’s the law.

On your “fish hooks”:

• A family who rents out their house while overseas for a year is not doing it with the main purpose of selling the house at a profit. They would not be subject to tax on their eventual capital gain.
• Different tax rules apply to boarders. But again, the home owner would not generally be subject to a tax on their gain because they had had boarders.
• You could, I suppose, own ten properties under ten identities. But that doesn’t affect whether your gains would be taxable.

Back to whether shares should be included: If you invest in shares that pay no dividends — so you are not receiving income year after year — or if you trade shares regularly, this suggests you bought the shares with the intention of selling at a profit. So gains on the sale of those shares should also be taxed.

But most shares pay dividends, and most share investors buy and hold their shares, so they can argue that they bought them for the dividend income.

One last thing: I’m not a financial adviser. I’m a writer and seminar presenter.

AI sent your letter to Inland Revenue Minister Peter Dunne for comment. His office responded, “It’s been decided that the reply will be from IRD and not the minister, as it’s really about how the department administers the law.”

Inland Revenue, in turn, responded:

“Gains on sale of property can be taxed, but only under certain specified circumstances.

“Regardless of whether or not a rental property is run at a loss, it is the taxpayer’s purpose or intention at the time of purchase of the property which is material for determining whether a gain on the sale or disposal of the property is assessable income.

“Where it is established a person regularly buys and sells properties, even when also residential landlords, Inland Revenue will look at the purpose behind the activity.

“In these circumstances, the onus would be on the taxpayer to satisfy Inland Revenue they are not dealing in property for gain on sale. Otherwise gains from such activity are likely to be viewed as assessable income and subject to tax.

“If you are audited, Inland Revenue will likely look at the reasons behind residential property investments.

“Taxpayers are responsible for their claimed tax position and should seek advice from their agent if in doubt about their correct tax obligations.”

To which I can only add: It’s one thing for someone to buy a rental property for the rental income and then find that in some years there is no net income — perhaps because tenants are scarce.

But, as I said above, many landlords who have recently bought rentals know before they buy that they won’t generate net rental income for years.

Even when the property does start to be profitable, it will take many more years for those profits to make up for the earlier losses.

Ask them, and they’ll tell you — unless you are Inland Revenue — that they bought for the purpose of selling later at a gain.

Regardless of whether they regularly buy and sell property, under the law they should be paying tax on that gain.

AGreat idea. Some people, though, say it’s better to exclude school clothes, fees and textbooks — which the parents want more than the children do. You might find your kid going without a textbook so he or she can buy cool shoes.

If you do let your teenager run their own budget, let them make mistakes, such as over-spending early in the month.

It’s an excellent way for them to learn the consequences when it doesn’t matter too much.

AIt’s not at all pedantic. I should have allowed for tax. But it doesn’t affect the calculations as much as you think.

You simply adjust the interest by your tax rate at the start.

If you are in the 19.5 per cent tax bracket, you will receive 80.5 per cent of the interest, and 19.5 per cent will go to Inland Revenue.

Let’s say the interest rate is 7.5 per cent. Multiply that by 0.805, to get 6.038 per cent. That’s the number to use in your calculations, or in an internet calculator.

In the 33 per cent bracket, multiply the interest rate by 0.67. In the 39 per cent bracket, multiply by 0.61.