Articles by Matthew Gilligan

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

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.

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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.

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Bernard commented on 30-Apr-2010 06:29 AM

Are you saying that real-estate may be a good buy if they do in fact "grandfather" previous depreciation rates? What are some other good areas based on your estimated depreciation laws. Disposable income is the name of the game and the reason why we still have several years before we are out of the woods. I've been playing a lot of lagging small caps during this run using http://www.microcapreports.com/

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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

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Rhys commented on 25-Nov-2009 04:24 PM

Nice article matt. Really enjoy your informed comments, keep it coming.

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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

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.

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