Articles by Matthew Gilligan

GST Issues for People Buying and Selling Property/Property Traders

Whilst it has almost been six months since the new zero rating provisions for land transactions came into force, at GRA we are still seeing quirks and issues emerge as practitioners and property traders / investors come to grips with the new rules.  In today’s article I want to examine two scenarios that those of you who are property trading should be wary of.

Scenario One

In scenario one a property trader has identified a potential trade property that is on the market for $200,000 including GST (if any).  The trader thinks that they could spend $20,000 making renovations and then sell it for $260,000.  The trader understands that they will need to return GST on the $260,000 but anticipates making GST claims on the $200,000 purchase price and the $20,000 renovation costs leaving a margin of circa $35,000 after GST and before income tax. 

Following this the trader submits an offer for $200,000 including GST.  The offer is accepted and our trader starts to look forward to renovating and making the $35,000. 

However, prior to settlement the trader seeks advice in relation to the GST treatment of the purchase and discovers that the vendor is a GST registered trader themselves.  This means the transaction of selling the land from the GST registered vendor to our GST registered trader is a zero rated transaction for GST purposes.  The $200,000 purchase price "inclusive of GST (if any)" now includes GST applying at a rate of 0%.  As a result our trader who anticipated having a GST refund of $26,000 in relation to the purchase of the property now has no GST refund.  Suddenly the $35,000 pre-tax profit is eroded because GST still has to be accounted for on the sale (note that we are assuming that the sale here does not occur to yet another GST registered party but it is a retail sale to an owner occupier / residential investor).

Possible Solutions

The moral of the story here is know your vendor.  If the vendor is GST registered and selling the property as part of their taxable activity and you are similarly GST registered and buying it for a taxable activity the GST component is zero.  In such a scenario you need to offer what you perceive as the GST exclusive value of the property to you - which in this case is $174,000 (being the $200,000 less the anticipated $26,000 refund that you are now not getting).  You can also consider including a clause in a contract making them warrant that not only are they not registered now but they will not be at the time of settlement and should they breach that warranty then the purchase price is reduced to reflect the fact that you will not get your GST input claim.

Scenario Two

In scenario two we are looking at a property trader whom is selling a property bought for trading purposes.  Our property trader is approached by a prospective purchaser who explains that they are GST registered and looking to buy the property in order to apply it towards a taxable activity (for example use as a commercial premises).  The purchaser therefore explains that they are willing to offer $400,000 inclusive of GST.  Our property trading vendor wants to clear $400,000 excluding GST and therefore had anticipated selling it to a retail investor for circa $460,000 so that after they had paid their $60,000 GST they still had $400,000.  This GST registered purchaser convinces our vendor that because its going to be a zero rated transaction they can sell it for $400,000 "including GST" because the GST component will be zero and our vendor will clear $400,000.  The vendor accepts the purchaser’s overtures and enters into the sale and purchase agreement.

Subsequently the purchaser changes their mind in terms of the use of the property they advise the vendor that they are now nominating a non-GST registered entity that will be buying the property for non-GST purposes (i.e. residential rental or to occupy as a residence).  This is disastrous for the vendor because now the $400,000 which was anticipated to include zero GST in fact includes GST at a standard rate meaning that our vendor has to account to the IRD for $52,000 in GST out of the $400,000 sale price.

Possible Solutions

If you are a vendor you could make the price “plus GST” instead of “inclusive of GST”.  If the contract is plus GST then a purchaser will have to pay GST at the standard rate if they change their mind (having initially said they will be GST registered).  Another strategy is to include a clause in the sale and purchase agreement whereby the purchaser warrants that they will remain GST registered at settlement and the transaction will be a zero rated transaction, and if they breach that warranty then the sale price is increased by 15% to compensate you as vendor for the fact that you will now need to account for GST.

Both of these scenarios illustrate the importance of understanding the circumstances of the other party in land transactions.  They also show that if circumstances change you can be placed at a disadvantage. 

As always we recommend you seek advice on your particular transaction.  Every transaction is different and you need to be vigilant in checking the terms of your sale and purchase agreement.  The above is comment of a generic nature only and should not be mistaken for specific advice in relation to any transactions you are involved in.  Contact us at GRA for advice on 09 522 7955.

If you are worried about any of these issues I have mentioned email or come and see me.

Matthew Gilligan
Director

Learn More about Matthew
Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

P.S. Did you like this article? Go ahead and sign up to our free newsletter and receive tips, updates and useful information to help you protect your assets and grow your net worth.  GRA are accountants who provide expert accountant advice both in NZ and offshore.

Tax Changes – Are you making a mistake with LTCs – Look Through Companies

Many of our clients come to us because they are not getting advice or they are not satisfied with advice they are receiving from other accountants.  In recent times the tax changes introduced by the National Government regarding property investors have created quite a stir and presented some challenges to investors in regard to making a decision as to whether to (a) convert their LAQC (Loss Attributing Qualifying Company) to a Look Through Company (LTC); (b) remain a QC (ie LAQC without ability to attribute losses); (c) revert to "ordinary" company status; or (d) migrate out of the company into individual ownership of the assets.

As a practice we have found varying levels of advice from our peers.  On occasion we have been somewhat disappointed for investors with the level of advice they have been receiving, and in this vein I introduce a number of common issues which we discuss with clients that we hope will assist you in making a decision as to whether to turn your LAQC into an LTC or follow an alternative path.  If any of these questions are not answered in your affairs, you are welcome to contact GRA and book a no obligation review of your LTC and get some answers to these quite tricky questions.

1. Quick overview of the changes – what should you be thinking about

With the introduction of the new LTC regime, LAQCs lose their loss flow through from 1 April 2011.  This puts you in a position where you will not be able to get tax refunds if your portfolio is negatively geared for tax.  In addition to losing loss flow through with LAQCs, depreciation has been removed from buildings from 1 April 2011.  For many investors that are near to breakeven cashflow in the current environment the removal of depreciation claims on buildings will see them tax neutral - rather than producing a tax loss.  For this reason they may consider not electing to become a Look Through Company and instead remaining a qualifying company or reverting to ordinary company status.

Against the reduction of depreciation claims as a result of the tax changes, is the artificially low interest rate currently being enjoyed by many investors with floating interest rates near to 5.75%.  The average 10 year interest rate in New Zealand is around 7.25% and investors are better to be planning for such rate in planning their long term cashflow and tax position and when making the decision as to whether to become an LTC or not.  If for example you currently have $500,000 worth of debt in your company/LAQC, your interest rate is 5.75%, each incremental increase in interest rates of 1% will cause you to pay another $5,000 of interest potentially causing you to become tax negative.  If interest rates spike up above the 10 year average investors could be paying a lot more than this at certain parts of the interest rate cycle and in such a higher interest rate environment they will be seeking to access the tax losses and without being a Look Through Company may not be able to do this. 

1. Common advice around the country varies.

It interests the writer that different practitioners in different regions in New Zealand seem to be giving different advice.  In the smaller towns around the country we have seen one view prevailing that investors are better to avoid the complications of Look Through Companies and simply use the transition rules provided under the new legislation to move assets from your company to individual ownership or partnership ownership.  In our view this is short-sighted because you end up paying conveyancing cost twice.  Firstly, because you need to transfer the assets physically and refinance with your banker when you make such a transition from an LAQC to individual / partnership ownership.  Secondly, later when you ultimately seek asset protection over your assets, you will then need to convey the titles again to a Family Trust which results in double conveyancing cost, whereas in LTC you can simply shift the shares and avoid conveyancing cost completely.

The alternative view therefore is to simply fill in a form and send it to the IRD electing to be a Look Through Company.  Such election magically converts your LAQC to be the new structure known as the LTC.  The LTC status then allows you to claim losses as if the assets were owned individually by the shareholders. In other words the IRD treat the LTC as being "transparent" for tax purposes and allow you to claim the tax losses - subject to deduction limitation rules.  These deduction limitation rules essentially require you to have real assets exposed to the company in order to get access to your tax losses.  For example if your company is 100% financed and you have personally guaranteed the debt, in theory you should be able to get your tax losses out as you formerly did with an LAQC.  However, IRD limit the deduction which you can get out of the company to being a combination of cash introduced to fund the losses and guarantees given by the shareholders to the company to support the banking facilities.  However, if such guarantees are not supported by real assets, the deduction limitation rules may not allow the shareholder to claim all of the losses of the LTC. 

I realise this sounds a bit complicated and the reality is that it is complicated - and the IRD are not forthcoming in resolving some of the uncertainties.  In the end, the best I con do in terms of simplifying is to say if you fund cash losses in a company you automatically get full flow through of such losses.  If you have losses in the company that you haven’t funded, for example losses from chattels deprecation, you need to have either an existing shareholder current account to take the loss out of the company or a guarantee provided to the banker that is supported by real assets within your group.  For most investors the deduction limitation rules will not be an issue in our opinion and therefore while rather complex to get your head around, in practical terms an LTC will provide for loss flow through and will become the new stable investment vehicle for property investors who are negatively geared for tax, just as the LAQC was.  Long term benefits of LTCs just as you could with an LAQC, are flexibility in the transfer of the owner of the asset because you can simply shift the shares of the company and thereby shift the underlying assets.  For example, if one spouse owns 100% of the shares of the property LTC, and enters into divorce proceedings.  If that spouse chose under the divorce proceedings to transfer the rental properties to their spouse, such assets could be transferred with a share transfer rather than paying for conveyancing cost.

This gives rise to one downside of LTCs which was not there for LAQCs, that being the issue of depreciation recovered.  Depreciation recovered occurs where the disposal value of an asset is greater than the book value, and such asset has been depreciated.  For example, if you have claimed depreciation on buildings and chattels life to date and you transfer a rental property to another person, then where the disposal value is at least original cost you end up paying tax on the depreciation you have claimed life to date.

Moving to the LTC point, because LTCs are transparent for tax purposes where you shift the shares of the company you are deemed to be shifting the underlying assets themselves.  You therefore have a disposal for tax purposes creating the potential for depreciation recovered.  This was not the case with LAQCs and is therefore a disadvantage of an LTC, but exactly the same disadvantage exists with general partnership or individual ownership of assets.

On balance we therefore like the Look Through Company structure over the alternative forms of investment being individual ownership or partnership ownership, for negatively geared investors.  By negatively geared the writer means negative for tax purposes. 

1. Common issues we see.

• Advisors not looking at asset protection when transitioning assets. 

When considering whether to trade as a partnership or a Look Through Company as two options that are commonly reviewed in the transition of LAQCs, one thing you should have your eye on is how will you protect your assets over Trust over time.  The ultimate outcome you should be seeking is good asset protection structures while achieving tax efficiency.  Tax efficiency looks at a number of different things but clearly if you have got tax losses emanating from your portfolio, you need to make sure your tax losses are accessible to the person or entity that earns the money such that you can get tax refunds and utilise the losses.  While a sole trader ownership or partnership ownership of the assets directly obviously gives personal access to the losses, it does make asset protection nigh on impossible because how do you get the equity into a Trust without conveying the title?  

With a Look Through Company you can acknowledge a debt for any equity advanced to the company or recognise capital growth within the company and declare a capital dividend resulting in a shareholder current account for unrealised gains, which can then be assigned to a Family Trust which thereafter provides for asset protection.  In other words you can distribute the capital gain from an LTC to the shareholders, assign that to a Trust and gift it into a Trust to achieve asset protection over the assets, while continuing to enjoy accessing the tax losses - subject to the limitations outlined above.  In this way your legal goals of asset protection is being achieved as well as your tax planning goals of accessing the tax losses.  The alternative of individual / partnership ownership does not achieve any asset protection and therefore is an inferior option in our practice’s view.  LTCs are much better for asset protection and provide the tax benefits. 

If your advisor has given a different view and you would like to discuss this with us, CLICK HERE for an interview.

• Who should own the shares? 

With LAQCs a typical shareholding structure was 99/1 in favour of the higher income earning spouse.  This was common in the investment property community and allowed the payment of a shareholder salary to the homemaking spouse where that spouse is managing the rental portfolio.  Such salary must be market value for work actually done and could be declared at year end.  The result was the spouse receiving the salary and being subject to a lower tax rate than the spouse getting the loss from the company.  A tax advantage emerged where normally the taxpayer would claim 33% tax on the salary while the homemaking spouse only paid perhaps, say, 11% on receipt of the salary.   

With Look Through Companies any salary paid must be subject to PAYE, shareholder salaries are not possible.  Secondly, where the salary is paid to an owner of an LTC engaged in property investment or trading such salary is non-deductible to the company (yet it is assessable revenue to the spouse).  For this reason it would be ludicrous to pay a salary in such circumstances. 

Where an investor does want to remunerate the work done of a spouse, they will only be able to do it and gain some sort of tax effectiveness from it where the spouse is not a shareholder in the company.  Therefore we believe it will become common practice for the previous 99/1 structure to become 100% held by the working spouse and the homemaking spouse will not hold any shares whatsoever.  This will enable spouse salaries paid on PAYE if the investors wish to do this, provided that it is market value for work actually done, a written employment contract is put in place and the other abovementioned factors are satisfied.

• What about debt deductibility? 

A common issue we see with accountants and advisors talking about choice of structure and LTCs with their clients is they fail to look at the long term issue of debt deductibility.  Common problems with debt deductibility that we see are the mixing of private debt with business debt, leading to business debt not being deductible.  This becomes particularly problematic where the family home is held by the partnership alongside the rental investments.  Separation of the rental investments in an LTC, with the home held in a Trust makes it much easier to clearly separate private and business debts, and preserve interest deductibility.  LTCs also allow you over time clearly identify the cash input to the portfolio as a separate shareholder current account and in some circumstances investors may be able to refinance private debt from their home into their LTC.  Strict criteria need to be met to achieve this and we recommend taking advice from an appropriately qualified person before looking at doing this.  We also note that this more difficult to achieve with partnerships and therefore another reason why you might want to go LTC instead of being in a general partnership.

If you would like to discuss debt deductibility issues or LTC issues CLICK HERE to book a meeting with Gilligan Rowe.

• Dealing with Gilligan Rowe / Booking a Meeting

Many of our clients around the country have their own accountants and lawyers but use us as experts to review their affairs and make sure they have good asset protection, optimise estate plans and the most tax efficient structure.  With the removal of gift duty coming up and anticipated to occur on 1 October 2011, the changes to depreciation rules and the LAQC / LTC changes, many people around the country are booking a meeting with Gilligan Rowe to meet by Skype or telephone, or in person if they live in Auckland, and take advantage of our very specialised practice that deals in optimising commercial structures for property investors. 

Matthew Gilligan
Director

Learn More about Matthew
Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

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Capital Gains Tax

Once again the topic of capital gains tax (CGT) has reared its ugly head.  Speculation is that Labour will unveil a property investment targeted capital gains tax when it announces its tax policy in the next two weeks.  The Greens have thrown their not so considerable economic muscle behind the proposed tax.  In light of this, let’s examine some of the arguments that proponents of CGT put forth:

• Capital gains should be taxed because there should be no difference in outcome between a taxpayer whom generates a gain of $50,000 through the sale of a capital asset and one whom earns $50,000 through salary.  In other words, taxing capital gains is fair and would create a more “pure” tax system with less incentive to direct investment into assets where there will be no tax to pay on gains.  This argument falters, however, when it seems inevitable that if there is a capital gains tax it will exclude one’s private residence and furthermore it seems as though Labour have their gun sights fairly and squarely set on property investors as opposed to share investors, for example.  There are also suggestions that there will be a threshold so that smaller capital gains are exempt.  Where is the fairness and purity in the tax system if the tax does not apply across all investment classes and furthermore there are exemptions within property?

• Capital gains tax will generate revenue to allow for tax cuts, possibly a tax free threshold.  The difficulty here is that a proposed capital gains tax may not generate the revenue expected and certainly not in the short term.  Again there is suggestion that property acquired prior to the introduction of the tax will not be subject to tax.  Furthermore, a capital gains tax may create a “lock in” effect whereby investors defer selling assets in order to avoid triggering the gain. 

• Capital gains tax will make property more affordable particularly for first home buyers.  It seems a bit defeatist to me to seek to solve the housing affordability problem by depressing house prices rather than raising real incomes.

• A capital gains tax will rebalance investment and redirect investment away from property and into more productive forms of investment.  In response to this may be tax is not the answer?  With finance companies failing and questionable practices from some in the financial advisor industry in the past, it is perhaps little wonder that property is such a popular form of investment.  Obviously there have been recent changes in relation to the regulation of financial markets, and it will be interesting to see what impact this has on investment biases of Kiwis moving forward. 

Some other points of concern in relation to the introduction of a capital gains tax include the fact that it is inevitably complex.  Once you move to exempt private homes or other classes of assets (for example, farms?) you exponentially increase the complexity of the proposed law.  You create incentives for people to structure their affairs to work around the capital gains tax.  There is also the issue of an immediate impact on property values.  This point often raised how desirable would it be for property values to take a material hit when off the back of a global recession many property owners are already heavily geared and would end up with negative equity.  What would be the knock on effects for lenders?

In the end, I can’t see how a capital gains tax will produce the outcomes that its proponents seek.  However, one outcome which I do see as a certainty is defeat for Labour at the ballot box if they proceed. 

If you require help with your property portfolio or tax return please get in contact with us at GRA we are here to help, CLICK HERE and fill in the form and we will be in touch otherwise call 09 5227955.

Matthew Gilligan
Director

Learn More about Matthew
Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

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LAQC / LTC TAX CHANGES

As you will now be well aware the LAQC / LTC tax changes are fast approaching.  They take effect 1 April 2011.  If you have an LAQC and you have not yet discussed with us what course of action to take you need to contact us urgently and book an LAQC/LTC review meeting.  As a recap some of the key points to note in respect of the rule changes are as follows:

• If you do nothing your LAQC will remain an LAQC, but a rule change from 1 April 2011 means shareholders of LAQCs can no longer claim tax losses.  In other words the LAQC loses the ability to attribute its losses to shareholders.  In most cases doing nothing is not an option.

• In conjunction with the LAQC/LTC changes, depreciation can no longer be claimed on buildings.  In many cases this means that tax losses that are currently being experienced will turn to tax profits.  This means you need to ask the question as to whether your current structure is appropriate given this change in tax result?

Broadly speaking if you have an LAQC at present you have a number of options available to you including the following:

• Do nothing and remain in the LAQC regime - although as noted you will not be able to attribute losses to shareholders.

• Convert the LAQC to an LTC, but leave everything else the same.

• Convert the LAQC to an LTC, but at the same time examine whether the shareholding structure in relation to the company is appropriate.

• Convert the LAQC into an ordinary company and potentially restructure the shares as well.

In summary, the changes to the LAQC rules and the implementation of the LTC regime means that all existing LAQC clients need to have their affairs reviewed to determine what the best structure is for them from 1 April 2011 onwards.  We are offering LAQC/LTC review meetings at a discounted cost of $150 plus GST.  Do not delay in setting this meeting up as you need to have the advice in advance of 31 March 2011.

Matthew Gilligan
Director

Learn More about Matthew
Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

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Now that the dust has settled on what was one of the most anticipated budget announcements in recent memory, now is time to reflect on the impact of the announced and proposed changes on property investors.  In doing so I am going to focus on the specific impact of the tax changes and leave aside for the moment the wider macro effects of the impact of this budget on the economy.  Broadly speaking there are five areas where the tax changes will impact on property investors.  They are as follows:

• The drop in personal marginal tax rates;
• The removal of depreciation claims on buildings;
• Proposed changes to the LAQC regime;
• Raising GST to 15%;
• Extra funding for audit activity at the IRD.

For advice on how the changes impact you contact us.

Depreciation vs Tax Cuts

Let’s take an example of a typical property investor that has taxable income from their job of $75,000 per annum and owns two rental properties that are currently worth circa $700,000 but were bought in 2002 and 2006 for $550,000.  For the 2011/12 income year if depreciation was still able to be claimed on buildings they would have been expecting to make a circa $6,800 depreciation claim which would have a maximum tax benefit of circa $2,200.  At the same time due to the cuts in personal tax rates there is an increase to their after tax income of circa $2,400.  Following this, the investor is $200 better off in the 2011/12 year.  It is also worth nothing that of course depreciation is usually claimed on a diminishing value basis so the amount that would have been claimed on the building moving forward would be reducing over time.  Finally, there is also the fact that in many instances depreciation claims produce a timing benefit only in that it is then recovered on sale.

Following this, we see the removal of depreciation claims as being mitigated by the drop in income tax rates (of course there will be additional private GST costs).

LAQC Regime

The budget announcement also signalled that there will be changes from the 2011/12 year to the LAQC regime.  At the moment the proposals are at issues paper stage only which means they are open for public submission until early July 2010.  The philosophy behind the proposed changes are to align the tax treatment of qualifying companies and loss attributing qualifying companies with limited partnerships.  This means that some of the same aspects that LAQCs have now will be retained in that tax losses will continue to be attributed to shareholders in proportion to their relative shareholding.  However, it also means a number of changes to other aspects of the LAQC regime.  It will mean that taxable profit is attributed to shareholders rather than taxed at company level and there is also a proposal to limit the amount of tax loss that can be claimed to the shareholders’ exposure in the investment. 

If you have an LAQC that may become tax profitable, then contact us for advice.

At this point in time the rules are not finalised but we will be watching this closely and it may well be that many investors who currently have properties in an LAQC will need to consider whether this is the appropriate structure for them moving forward. 

If you have an LAQC with property in it, contact us for advice on restructuring prior to the rules changing.

The fact that depreciation on buildings has been removed, which may lead to a decrease in the tax losses (or perhaps even some properties even becoming profitable), along with the proposed changes to the LAQC regime mean that a review of structures is necessary.  If the changes continue to proceed as proposed affected investors would be best placed to restructure prior to 1 April 2011.

If you are selling property and want to know about the impact of depreciation recovery then contact us.

Likewise if you are buying property and want to know if the LAQC is still the right structure then contact us.

The rise in the GST Rate & Audit Activity

The rise in the GST rate will not have a discernible effect on residential property investors other than expenses that they currently incur that attract GST will increase without the ability for the GST to be reclaimed.  There will be an impact on property traders and commercial property investors however.

If you are a property trader you need advice on transactions occurring around 1 October 2010 when the rate changes.  Please contact us for advice.

It is also worth noting that extra funding is going to be provided to the IRD with one of the focuses being the property industry.  As a result we encourage property investors to make sure that they are involving professionals in the preparation and filing of their tax returns and making sure that they are getting appropriate tax advice in relation to property transactions.

If you are concerned about tax treatment on past transactions or need advice on current ones, then contact us

Overview

Overall we think the budget was a largely positive one for property investors even in respect to the tax changes.  Certainly leading into the budget there was talk of ring fencing of losses, which has not come to fruition and would have had a much more significant impact on the property investment sector.  As it is the removal of depreciation claims on buildings from the 2011/12 year will definitely impact on property investors, but perhaps for property investors any impact of this will be matched by gains to the drop in personal tax rates.

Matthew Gilligan
Director

Learn More about Matthew
Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

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The Tax Working Group report was publicly released at a press conference yesterday, 20 January 2010.  Please read our summary including our response of interest to property investors. 

The full report can be read in full HERE.

The highlights of the report seem to be:

Ring Fencing of Losses

Targeting of Existing Property Investors

Targeting existing property investors in this way (taking their wealth) is not fair, neither is it in the public interest in the writer’s view. I hope the government works this out and decides not to change the depreciation regime. Trailing it and hurting average mum and dad investors that make up the bulk of the investment base in residential property. These are ordinary (voting) public trying to get ahead.

Perhaps the government should consider the political popularity as it will certainly impact voting. This will not be an election winner for them; hundreds of thousands of investors will be affected.

Also consider the banks position. Many investors are geared (borrow) 80% of the property value. If property prices drop 10-20%, banks will be in breach of their banking covenants and be obliged to call up loans and mortgagee sell investors. This will destabilise the banking industry, - totally unacceptable one would think.

Consumer Spending

Reduced house prices and reduced disposable income from investors will also dampen consumption. Not good at time when the government is trying to re-activate consumption.

However, if the depreciation regime is grand-fathered (affecting new investors, leaving existing investors as they are with current rates until they sell existing property), the impact would be less of an issue.

This addresses the 'level the playing field' argument between property and shares (an argument I don’t agree with, that is driven by people with vested interests in shares like Brash (a shareholder in Huljich Wealth Management) and Weldon ( NZSE CEO).

These people have huge upside in attacking property, and personally I do not believe this issue has been addressed by the media.

Summary

In summary my primary concern surrounds the depreciation rate changes: if the rates are to be changed, or to be set to zero, grand-fathering the old rates would be the middle ground and more sensible in my view, to protect existing investors, the banks and the economy in general.

Would you like assistance with a review or understanding how your affairs may be impacted by any possible changes in legislation? If so, please contact us for an interview. We can work NZ-wide and globally by phone, email or Skype.

Matthew Gilligan
Director

Learn More about Matthew
Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

P.S. Did you like this article? Go ahead and sign up to our free newsletter and receive tips, updates and useful information to help you protect your assets and grow your net worth.  GRA are accountants who provide expert accountant advice both in NZ and offshore.

If you are a DINK household (double income no kids) then the ideas in this article could help you grow your wealth and protect your future.

The Smiths

Mr and Mrs Smith are a professional couple. Mr Smith is a doctor and Mrs Smith a lawyer. The Smiths are your classic DINK  pair. Between them they earn circa $250,000 taxable income per annum. They own their home which has a market value of $750,000 in joint names and debt in relation to this is $200,000. The Smiths are now looking at property as a way of investing in their future and growing their current equity. Two issues emerge out of this. First, what sort of property should the Smiths be looking to buy and second how would they structure it.

What Property to Buy?

Based on the Smiths’ income earning potential and assuming that they have many years of this income earning potential to come, they could choose to focus on properties that have high capital growth and moderate to high yield. As an example they might find a $500,000 property that rents for $625 per week.

This represents a 6.5% gross yield. A 6.5% gross yield is a moderate yield only, but the property has high capital growth potential. Based on a short-term interest rate of 6%, the gross rent will cover interest but after other expenses are taken into account such as rates, insurance etc the property runs at a $5,000 cash loss.

This means the property costs $100 a week to fund. However, we haven’t taken into account depreciation or tax refunds yet. If we work on the basis that there would be depreciation deductions available in respect of this property of circa $9,000 per annum, there would be a total tax loss of $14,000. As the Smiths paid a lot of tax in the 38% tax bracket, they will get 38% of this $14,000 tax loss back leading to a tax refund of $5,300.

What the above has illustrated is that the Smiths have been able to secure a high capital growth potential property at no ongoing cost to them as the cash loss is covered by their tax refunds once depreciation deductions are taken into account.

How to Structure

In terms of the structure, the Smiths would establish an LAQC to own the property. Assuming they earn relatively comparable incomes and expect that situation to continue in the future, they will each own 50% of the shares in the LAQC. In order to enhance their asset protection they would establish a Family Trust and move their home into the Family Trust. To help minimise exposure of their home to bank debt they would seek to utilise two banks when borrowing to buy the property. That is, they would secure $100,000 of new debt against the home, which would then provide a deposit so that a second bank would provide the other $400,000 required secured against the new rental property.

In summary, the Smiths with their high disposable income are able to get ahead by buying a property with good capital growth prospects and enough of a gross yield so that it is cashflow neutral.

In other words, they buy capital gain in the property for free.

Let GRA help you with your property investment and structures.  Go ahead and request a free interview now.

Matthew Gilligan

A common question that I get asked is – what impact do rental losses have on my entitlements to Family Assistance? Before I answer that lets just go back a step and talk about Family Assistance...

First, the technical name is now Working for Family Tax Credits (WFTC). They are entitlements that families with children may qualify for depending on the number of children you have, the household income and the hours each week you work. As a rough guide a family with three children can qualify for payments under this scheme with household earning of up to $105,000.

As your entitlement to WFTC is dependent on your level of income the question then is – can you take into account rental losses in calculating your income for WFTC purposes?

The answer to this is not as straight forward as you might think. If the rentals are owned in an LAQC then the answer is no, the losses are not taken into account. This means even though your attributed loss from the LAQC will reduce your taxable income and the income tax that you pay thereon, it will be disregarded when assessing your income and eligibility for WFTC purposes.

Now whilst that may or may not surprise you I am sure that this will. If you own a rental property personally the losses are taken into account for WFTC purposes. This means if you have a loss-making rental property owned in personal names you will qualify for more WFTC support than you would if you owned the same rental via an LAQC.

Now to further confuse things, if you have a business and the business produces a tax loss, that loss is also ignored for tax purposes. What this means is that if the IRD regard the rental activity that you conduct personally as a business then the losses are ignored, just as the LAQC losses are.

This begs the question as to what qualifies as a business. It seems clear to us that one rental property does not qualify as a business and therefore you are safe to assume that the losses from one rental property can be offset against your income for WFTC purposes. If you own two or more rental properties personally then it may be that the investment activity constitutes a business and the losses are ignored. Each case needs to be treated on its own merits.

As we have been pondering this here we have been trying to work out the policy rationale behind the rules. It can not be that the government did not want depreciation deductions in respect of rental properties influencing WFTC payments as if that were the case the law should not allow a single rental property owned personally to be taken into account for those purposes. It seems on the face of it to suggest a policy whereby investment and business activities are discouraged. However, even this does not explain why tax losses from an LAQC and businesses are excluded and rental losses from a single rental property are not is puzzling.

It is also worth noting that the exclusion of the LAQC losses for WFTC purposes contrasts with assessments in relation to child support, which do include LAQC losses. Obviously the policy issues are somewhat different, but the contrasting treatment is worth noting.

Given the law is what it is, this begs the question as to whether you are better off owning rental properties personally or in an LAQC. If you do qualify for Family Assistance there may well be benefit in owning the property personally but you need to weigh up the impact that this will have in terms of additional WFTC support versus potential downside of owning personally as opposed to an LAQC in terms of loss of ability to stream the tax losses through the higher income earner, ability to pay shareholder salaries and potentially the ability to structure debt in an advantageous manner.

It may well be that the flexibilities and rewards of LAQC ownership outweigh the marginal increases in WFTC but again each case should be judged on its own merits.

If you have any queries or concerns regarding to the interrelationship between WFTC and rental losses please contact us at GRA.

Matthew Gilligan
Director

Learn More about Matthew
Contact Matthew at mg@gra.co.nz or call +64 9 522 7955

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