Capital Gains Tax (if it happens): what will be the effects on rental properties? What strategies could be employed to minimise tax effects? Here is a high-level overview:
WHAT WILL BE TAXED?
Everything except your grandma.
No, not quite. All land except family home, shares, business assets and intangible property. Seems that cars, boats, jewellry, fine art, collectibles and other household durable items would also be excluded.
HOW MUCH TAX?
At present, it would be at the tax rate of who/whatever owns the asset i.e. if a person, and they are earning $70k/year, then 33c/$. However, the common view is that this will be watered down to something more like the Australian rate, which is a flat 15c/$.
That being said, the proposal is to extend the lowest tax threshold of 10.5c/$ from $14k/ year to $20k/year, which is $420/year extra. Break out the party poppers.
Note also, that the proposal includes allowing depreciation on buildings once again. The more things change the more they stay the same! It would also allow deductions for seismic strengthening, something more likely to help commercial property investors.
WHAT'S THE TIMEFRAME?
It isn't going to be backdated, but seems that businesses will have up to five years to work out what the market value of the assets as at April 2021 was.
WHO WILL BE TAXED?
You'll pay CGT on your worldwide assets if you* are tax resident in NZ, e.g., sell a rental property in Australia: CGT will be calculated in NZ. One would imagine however, that where there is a Double Tax Agreement (DTA), then that country has primary taxing rights, and NZ would recognise the CGT paid on that asset sale.
We asked MortgageLab to give us their unique perspective as mortgage advisors. You'll enjoy reading some useful insights and tips from Rupert Gough here.
Forsyth Barr make the following observations:
For more insights and advice on your portfolio, go to
* By "you" we mean the entity that owns the asset
+ Note that if you use part of your family home for Airbnb or want to claim home office costs or if the home is bigger than 4500 m2, then CGT would apply. See this link for more info.
Reference to comments by Mortgage Lab and Forsyth Barr is done with kind permission of each party. This does not constitute an endorsement of Epsomtax.com Limited. All rights belong to their respective owners.
BILL SUMMARY FROM IRD
Ring fencing of property losses is here to stay. What will be the impact, and what strategies should you employ? How will it affect you? Will you still get a tax refund? Here is the latest summary from IRD and our discussion below.
So, from 19/20 financial year it is much harder to get losses from your rental onto your personal tax return. And therefore, goodbye tax refund for most; less refund for others. Rents will likely rise as investors can't get a tax refund to the same degree. Some investors will opt to sell. Others will be able to grow their portfolio.
This blog post has some good stuff in it, but see also our latest post here
* IRD stated in the draft bill: "... we suggest that the ring-fencing rules generally apply on a portfolio basis, so a person with multiple properties would calculate their overall profit or loss across their whole residential portfolio... we are recommending that taxpayers who wish to elect to apply the rules on a property-by-property basis be able to do so. We... do not consider that ring-fenced losses should generally be fully released on a taxable sale of residential property, meaning the losses (if not exhausted from offsetting the income derived on sale) would be able to be used to offset other income. However, for those properties which have had the rules applied to them on a property-by-property basis on the taxpayer’s election, we recommend that the losses become fully unfenced if they are taxed upon sale. This would also be the case where the rules applied on a portfolio basis and all of the properties in a portfolio were sold and taxed. This would most commonly be the case for land that was taxable under the bright-line test because it was sold within five years of acquisition."
So, what does that mean?
The Tax Working Group (TWG) has published its interim report. What will be the impact on property investors? Please see the PDF below for an executive summary, courtesy of Forsyth Barr.
THE GIST OF IT
Basically, the TWG wants to extend taxes on capital gains to things other than property. But, they are also looking at reintroducing building depreciation, so it is not all bad for property investors.
TAX ON CAPITAL INCOME
A capital gains tax (CGT) regime for property and share traders/developers etc already exists in New Zealand, so this is nothing new. The TWG recommendation is to extend this to catch gains on assets that are not already taxed:
IMPACT ON INVESTORS
Some key points:
For more information, please contact either Guy Johnson or Paul O'Driscoll or via the details below.
Content posted by kind permission of Forsyth Barr. This does not represent endorsement of EpsomTax.com Limited or its related companies by Forsyth Barr. All rights and trademarks belong to their owners
We are sometimes asked: what does "tax-deductible" really mean? Does it mean that I get all my money back? Well...
When an item is tax deductible that means that the cost is able to be deducted from taxable income or the amount of tax to be paid.
All purchases are either 100% tax-deductible, partially tax-deductible or not tax-deductible. A 100% tax deductible item does not mean you get 100% of the money spent back. It means that you can claim 100% of the cost against your taxable income. A 50% tax deductible item e.g. phone, means you can claim half the cost against your income.
So, let's say that you want to put new carpets in your rental property. The cost comes to $4000. This would be 100% tax-deductible. You can claim all of that cost against the rental income the property is earning.
But let's then say that you are at the supermarket, and you forgot your personal credit card. So you pay for your groceries from your rental property account. This would not be tax-deductible.
HOW MUCH TAX WILL I GET BACK?
So, how much do you get back when you buy a tax-deductible item? Well, it depends on how much tax you pay. The maximum tax rate is 33%. So the maximum tax refund is also 33% i.e. You will never get back more tax than you actually paid. So we suggest as a rule of thumb: divide the cost by 1/3. This gives you a rough idea of how much tax you might get back.
Of course, tax refunds are subject to things like: were you correctly taxed at your job? Are the property losses ring-fenced so that you get little or no personal tax refund? Is your rental property owned by an LTC, partnership or sole trader that allows losses to be passed to the owners (under current laws) or is it owned by something like a trust or standard company, which don't?
If you have further questions, please place a comment here or contact us.
WILL IT HAPPEN?
Hard to say. Now the cat is out of the bag, it might be hard to put it back in. It is, however, worth noting that attempts have been made to control the property market by brute force before, and they ultimately resulted in a change of government. In the early 1980's, the then Prime Minister, Mr Robert Muldoon, introduced a rent and interest rate freeze in an attempt to control property market growth. The result was that no one could get finance, and so no one could sell either. Eventually, this regime was repealed.
There has been some very strong push-back by influential companies and bodies, which is to be expected. So, we wait and see.
Meanwhile, let's talk about possible strategies:
Until where know where things are going to land, these are only ideas to consider at this stage - although point 1 is probably a bit of a no-brainer.
RESIDENTIAL LAND RICH
IRD have proposed that any entity which is not "residential land rich" won't be subject to the ring-fencing rules.
Please explain?! Well, this is a bit tricky. An entity is which is not "residential land rich" is any entity wherein 50% of more of its assets are not rental residential property. For example, an entity e.g. LTC buys a residential rental, and also buys a commercial property and the value of the rental is less than the value of the commercial property (as measured by open market value of the assets at year end). The shareholders would need to borrow the money and inject the capital into the company. The shareholders could then claim a deduction for the interest in their personal tax returns, and thus offset any profits coming from the company. And if the interest cost is greater than the profits, then that would be a loss to record on their personal tax returns.
However, this would really only work if starting from scratch, and in our view, there are better ways to do it than this method.
You have a mixed-use asset if, during the tax year, it's used for both private use and income-earning use, and it's also unused for 62 days or more.
The rules apply to any:
See here for more info.
So in other words, a mixed-use asset means you have to use it a bit yourself, e.g. a holiday home that you mostly rent out, but that you stay in a bit during the year.
There are various rules (outlined in the above link) which limit what you can claim from these kind of assets, and you have to be careful if you think your gross annual income will be more than 60k (GST registration; that's another issue - especially when it comes to sale time), but it bears thinking about.
SET IN STONE?
By no means. We are recommending a wait-and-see approach at this stage. But start thinking ...
You might find our earlier article on this subject useful as well.
Shock! Horror! IRD released a proposal to ring-fence rental property losses. What does that mean for you?
At present if you own a rental property (sole trader, partnership, LTC) and it makes a loss, then you can offset that loss against your personal income or the income of the shareholder/s (in the case of an LTC). This means you pay less tax or get a tax refund. In IRD speak, that is
"Currently investors (particularly highly-geared investors) have part of the cost of servicing their mortgages subsidised by the reduced tax on their other income sources."
Thousands and thousands of Mums and Dads across New Zealand have become landlords in this way, and the tax refunds help pay for the mortgage.
From 2019-20 tax year onwards, losses won't be passed on to the owners, so no more personal tax refunds. Instead, ring-fenced residential rental* or other losses from one year could be offset against:
Solutions for Investors
IRD make this comment:
It is suggested that the loss ring-fencing rules should apply on a portfolio basis. That would mean that investors would be able to offset losses from one rental property against rental income from other properties – calculating their overall profit or loss across their portfolio.
So, our initial thoughts are that investors with negatively-geared property need to look at
Where to Read the IRD Proposal
Goto this page
Check out Part 2 here
* If your house is a Mixed Use Asset, ie you use it as a holiday home that you rent out to others, then the rules wouldn't apply to you. They also don't apply to your "main home" ie where you live, or if you are buying and selling houses for profit e.g. a trader.
Why is a chattels valuation necessary?
Typical valuations assign a valuation to chattels of $10-15,000. However, they often miss many depreciable items, such as driveways, fences, decks, paths, hot water cylinder, letterbox, garage door motor etc.
When you obtain a chattels-specific valuation, typically the value of the chattels for a new home is $45-50,000+ and for one built in the 1980’s $25-30,000. Even if your chattels valuation comes out at only $30,000 then the value for the tax refund will be around $10,000. The higher the chattels value, the more depreciation can be claimed, which means less tax to pay or larger tax refunds.
Are there any exceptions?
The only exception to the chattels valuation, is if it was a rental already owned by you or another entity you controlled, and you had already filed a tax return for that property at least once. In that case, we can’t “re-value” the chattels.
What will it cost and who does this?
We know of only one firm: ValuIt. Visit their website www.valuit.co.nz or call 0508 482 583 to book a valuation. Please note, we receive no financial incentive or otherwise for recommending them. However, we encourage you to do this without delay, as they are very busy and it can often be 2-3 weeks before someone can get to see your property.
Depreciation: Simple Overview (video)
6 Minutes on Depreciation (video)
Depreciation Clawback and Your Rental Property
Depreciation of Chattels in Your Rental Investment Property
Valuation of Chattels - Why Necessary
This page is not in alphabetical order, but in order of Top Questions first:
Tax Return Filing Dates
Q: When does my tax return have to be in i.e. filed with IRD?
A: If you have an Extension of Time to file, the date is 31 March. If you are linked to a Tax Agent or Accountant, then usually you will have this extension. Note that the IRD must receive your tax return by this date i.e. if you post it on this date, it will be late.
Q: Cool, so I can send my info to you guys about the middle of March and that will be ok then? That gives 2 weeks to get it sorted, right?
A. Sorry, but no. In order to get the figures right, there is a process of many eyes checking your financial statements/tax return/s. So we recommend that you allow at least 5-6 weeks for us to collate, code, compile, check and file your financial statements and tax returns.
Q: I didn't earn any income last year, but I am a shareholder in a Look Through Company. Do I have to file a tax return?
A: Yes. You will have income or loss from the LTC and this has to be declared to Inland Revenue via a personal tax return.
Q: My rental is running at a loss. Why don't I get a tax refund anymore?
A: You can blame the government for that. They changed the rules so that losses from rental residential property, are "ring-fenced". That means they can only be offset against profits from the same kind of income. Read more here. What do do about it? Read about our recommended strategies here.
Q: I don't see any impact of the LTC losses to the final tax figure?
A: Please see the example IR3 tax return below
How Do The Amounts On The Profit & Loss Relate To My Tax?
Here is a typical Profit & Loss report. You can see the Profit hi-lighted in yellow, and the Expenses hi-lighted below (also in yellow). Then at the bottom, you can see that the result is a Loss - which is why it is written in parentheses (brackets).
This loss amount (or negative amount) is then put on your tax return. It offsets other rental income you have received. In this sample, assuming the person is being taxed at 33c in the dollar (ie they earn over $70,000 per year), then they could offset the loss of nearly 11k against other rental income (or if they have none, then this loss would be carried forward to future years).
How is the Tax Calculated?
All sources of income are added, e.g. wages, interest, dividends. Next, all sources of loss are added, e.g., LTC losses. Then tax is calculated on the sum of all of these figures. After that, tax that you have already paid is deducted, e.g., RWT, PAYE, provisional tax. The resulting figure is either a debit (tax to pay) or a credit (a tax refund).
Dividends - AECT/Entrust
Q: Why does the IR3 (personal tax return) you sent me show a dividend of nearly $500 from Entrust (formerly the Auckland Electricity Consumer Trust or AECT)? I only got about $300-something?
A: The Entrust dividend is shown on the tax return as follows
Using this formula, we arrive at the $300-something you received. You can see the exact breakdown here
Q: Why does the tax return show this? I wanted the refund to be credited to my bank account?
A: That's exactly what this means. It says, in effect: "do you want to receive the refund in cheque format?" The answer is "No." IRD only gives one other option, and that is a refund to your bank account.
Q: Does my LTC get a refund as well as me?
A: No. If you have an LTC, the refunds go to you. The company is Looked Through at tax time, hence the name Look Through Company.
Q: Is the amount shown as a refund what we're going to get?
A: Probably. All returns filed are subject to review by IRD, and sometimes they don't agree with our calculations. There are a number of reasons for this:
However, don't panic. All errors, wherever they are made, can be easily rectified.
Q: What's an IR3 form? What's an IR526? How long does it take to file a return?
A: That is what the personal tax return form is called: an IR3. (If you are not NZ tax resident, the form is an IR3NR). The actual filing online takes about half an hour. Then IRD processes it, which can take anywhere from 1 week to 12 weeks or longer. Once they’ve processed it, you then receive your tax refund.
The IR526 is the donations rebate form; it has to be processed separately. Note that you can now login to myIR and upload your own donations during the year, and IRD will process them once your personal tax return is done.
Q: I own a rental property, or I'm self-employed. Why is ACC sending me a bill?
A: If you received rental income in NZ and you didn't use a property manager, ACC can still charge you. And if you are self-employed, you have to pay ACC Employer and Earner Levy
These questions are based on questions asked by customers. We'll be adding more examples to this page as they occur.
Other FAQs you might have:
RENTAL PROPERTY: WHAT RECORDS DO YOU NEED TO KEEP?
USING ACCOUNTANCYONLINE.CO.NZ/MY TAX QUESTIONNAIRE
HOW DO I DOWNLOAD TRANSACTIONS FROM MY BANK'S ONLINE INTERNET BANKING?
WHAT IS XERO.COM?
WHAT'S THE PROCESS FOR MY TAX RETURNS?
COMMON QUESTIONS ABOUT YOUR FINANCIAL STATEMENTS
You've established that there are good economic reasons for changing the shareholding in your LTC that owns rental residential property. You and your life partner are the shareholders. What things do you need to consider so that you don't get hit with a nasty (and unexpected) tax bill?
1. Brightline Test
2. Shareholders Current Account
Let's say that the company owes the shareholders $150,000. This is tracked in the Shareholders Current Account, and is a liability (debt) of the LTC.
Bob has 99 shares, and Mary has 1. Bob will sell/transfer 49 of his shares to Mary so that they each have 50 shares. Let’s say at the moment, Bob and Mary are owed $75,000 each by the company.
The LTC has made losses so is technically “insolvent”. The ramification of this is that as 49% of the shares are transferred there is a deemed disposal of 49% of the both advances being a total of $73,500 at a market value of zero (due to the company being insolvent).
Under special tax rules the $73,500 is initially deemed to be income of the LTC to be taxed to the owners in proportion to their shareholding (Bob $72,765 and Mary $235). Under recently-amended income tax rules, this income will not be taxed to the extent it is in proportion to shareholding. In this example Bob has debt of 50% for a shareholding of 99% and Mary has debt of 50% for a shareholding of 1%. Under the new rules he will be taxed on 49% of the debt being $73,500 and Mary will not have taxable income.
In this scenario, the de minimis* threshold of $50,000 would be exceeded when Bob transfers his shares (as the deemed income is $73,500). This same issue arises when either the LTC status is revoked or the company is wound up.
Going forward, ideally all LTC shareholder debt should be in proportion to shareholding. Between family members this can be achieved by way of an assignment of debt as that is another way of presenting what is happening. Then going forward debt should be transferred along with shareholding so the debt stays in proportion.
3. Depreciable Assets With Costs Over $200,000?
Is the cost of any of the LTC’s depreciable assets more than $200,000 each? If so, you then need to ask: Is the value of the accumulated depreciation on assets per shareholder more than $50,000 (the "de minimis" threshold)? If so, then there could be tax implications.
Be aware that changing shares now (or ownership % in a partnership) partially starts the 10-year Brightline Test again.
For example, if you moved 5 shares (of a total of 100) from you to your wife, then sold the property within 10 years of that change, then 5/100 (5%) of the sale profits (sale price less fees less original purchase price = sale profits) would be classed as taxable income (for the person who “sold” the shares).
So, if the gain was $100,000, 5% is $5,000. So in this scenario, $5,000 would be taxable income.
Please contact us for advice. You may also want to read this related blog article "Are Tax Benefits a Good Reason to Make Changes?"
* "de minimis" is a Latin expression meaning about minimal things, normally in the locutions de minimis non curat praetor ("The praetor does not concern himself with trifles") or de minimis non curat lex ("The law does not concern itself with trifles") a legal doctrine by which a court refuses to consider trifling matters.
This year (2016) we've seen a dramatic increase in requests for information from IRD, generally, letters where they want a more detailed breakdown of expenses. We've also seen some more "direct" methods employed. What is this all about?
Focus On Property
This year, as in previous years, IRD is continuing to focus on property. Why? Well, see articles like this at NZ Herald:
The Herald reports: "Inland Revenue's 52-strong property compliance team has generated an extra quarter of a billion dollars that landlords and property flippers avoided paying in the past five years. The team is spread around the country, with a strong focus on the hotspot of Auckland, and is charged with finding people who have not paid the required tax on rental income or property speculation."
So, the government has given IRD more money to find property owners who aren't paying the tax that they should. The results have been quite spectacular, and so the IRD has been given even more money to follow up. You can see how effective the program has been from looking at the Herald graphic. Really, this is good news for everyone as tax cheats hurt us all.
However, this also means that law-abiding people sometimes are caught up in this effort, and asked to provide extra info. And as mentioned, we have certainly seen an upswing of queries from IRD.
The "Direct Method"
IRD have starting calling people directly, instead of via their accountant/tax agent. Frankly, this can be intimidating. However, please feel free to refer them to your accountant (it is your right to do so).
Is there anything you can do to minimise risk? Well, apart from being honest, you may want to take a look at AuditShield insurance. Contact us for a quote. You may also be interested in reading WHAT DOES AN IRD "REQUEST FOR MORE INFORMATION" LETTER LOOK LIKE?
NB: This article does not imply any endorsement by NZ Herald or its writers. All rights belong to NZ Herald.
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