It’s that time of year again – time to file your return. Yet, while you wrap your head around filling out those dreaded forms, it will pay to consider the proposed and impending tax changes that lie ahead for residential property investors. The proposed changes include ring-fencing losses from rental properties and extending the bright-line test from two to five years; while another possibility being investigated is the introduction of a capital gains tax (CGT). To help you make sense of the changes, we’ve spoken to industry experts on what you should expect and how you can better prepare for the new tax regulations.

How And When Will Changes Be Implemented?

“Given that there isn’t any policy as yet in the pipeline, it’s difficult to speculate on exactly how and when changes will be made,” says Gilligan Rowe & Associates director Matthew Gilligan. However, he says “some informed guesswork can be done” and the devil will be in the detail.

We do have some clarity on the extension of the bright-line test, Revenue Minister Stuart Nash confirmed last month the election ‘’promise” to extend the bright-line test to five years will be enacted, effective for properties acquired after the date of Royal Assent (likely this month).

Ring-Fencing Losses

NZ Property Investors’ Federation (NZPIF) executive officer Andrew King says this tax change is the biggest factor that will lead to a reduction in the number of rental properties available to tenants.

He says NZPIF’s studies show the top-up cost of owning the average rental property currently sits at around $6,500 each year.

“If ring-fencing is introduced that cost will go up to around $10,000. It will have a really big effect on people providing new rental properties.”

Gilligan says ring-fencing losses will only affect “buy and hold” investors who invest long-term.

“Proposed policy is ring-fencing losses derived from property investment – so that is likely to exclude property traders, developers, dealers and land and property builders.”

The Government recently said they’ll phase the policy in over five years. “The only logical way they could do that is do it 20% per annum,” says Gilligan. This means, “in year one you can claim 80% of your losses and carry forward 20%, in year two you can claim 60% of your losses and carry forward 40%, and so on, and so forth.”

Gilligan says this is the responsible approach to implementing the change.

Withers Tsang director Mark Withers says buying property, with no ability to offset losses, will mean people will be, “legitimately questioning if that’s an acquisition that they want to make”.

“It will probably achieve to some extent what the Government is hoping, which is to drive down the value of property, because investors will just simply set their expectations where they are likely to break-even or have a small bit of cashflow.”

There’s no indication yet on when the new regime will be adopted, and Withers puts this down to the complicated nature of reforming tax law.

“The Look Through Company (LTC) regime was specifically designed and created to ensure that losses in companies could flow, and offset other incomes of an individual owner, and because of that it’s become a popular structure for property investors,” says Withers.

“So, you would have to assume that if they are going to do this ring-fencing it would need a complete overhaul of the LTC regime.”

What Can Investors Do?

Withers says getting rents up to a level where you’re either breaking-even or are positively geared is something some investors will be able to do.

Alternatively, “if you had a portfolio of property you owned and you had very low yields, you might sell enough of that portfolio down to bring yourself into profit.”

But will changing your ownership entity help?

This is a question Gilligan has been asked many times and the answer, unfortunately, is “no”.

“It’s entity-neutral,” says Gilligan. “Logically it will affect all tax entities the same.”

This means the changes will likely affect Company Trusts, Look Through Companies and sub-traders equally.

‘If ring-fencing is introduced the cost [of owning a property annually] will go up to around $10,000’ ANDREW KING

What's The Market Impact?

“If you stack everything against investors, they’ll just stop wanting to be investors,” says Gilligan. “The magic wand does not produce cheap houses and lower rent. What it does is it kills supply and causes investors to get out of the business so you get less housing stock, less rental stock and it’s contrary to their supply targets.”

“What is causing house price inflation is the ability to leverage, not [tax benefits]. I think the better button for the Government to push to stop house price inflation is the loan-to-value ratio [LVR] rule. That’s the silver bullet.”

Withers says the new tax law might actually focus investors on the economic returns their assets are producing and cause some investors to streamline their portfolio.

“To be honest, that wouldn’t be a bad thing.”

“They want property investors to start selling property. If you’ve got lots of property investors taking property to the market you would think that prices might drop.”

King says while some may choose to sell up, conversely “it may stop new people from coming into the industry and that will negate any positive impact from those choosing to sell”.

What Are The Changes?

Ring-fencing losses The Government has promised to remove the ability to offset losses from rental properties against other forms of income.

Bright-line In Labour’s pre-election tax plan, the party pledged to extend the bright-line test that taxes the profits made on the sale of properties, other than the family home, from two years to five years.

Capital gains tax (CGT) The Government set up a Tax Working Group with the aim of investigating, “possible options for further improvement in the structure, fairness and balance of the tax system”. In particular this Group will look at a capital gains tax.

Who Will Be Affected?

“[Ring-fencing losses] isn’t going to affect all property investors equally,” says Withers. “It’s grossly unfair on those who are trying to become property investors or are still relying on debt funding.”

Interest rates are currently in the 4-5% range, but if rates soar costs will increase and put added pressure on investors who have negatively geared their property.

“It’s beyond the control of the average property investor, the only thing they can do is fix loans,” says Withers.

Gilligan agrees it will be hardest on those investors just starting out, who have no ability to streamline their portfolio.

“When I ran a quick poll [of 700 investor clients] online, only 15% of my client base are claiming losses.”

But he says it’s those “Kiwi battlers” who will struggle.

“Poorer investors will be served up like a dish to the wealthier investors,” says Gilligan.

Extending Bright-Line To Five Years

Extending the bright-line test from two years to five years might, ironically, restrict supply, says Withers.

‘Poorer investors will be served up like a dish to the wealthier investors’ MATTHEW GILLIGAN

“Let’s say you were at year three on a hold, and you realise that you’d be better doing something else that was financially more prudent. By locking people in to keeping it two more years the Government misses out on the tax they might have got.”

Gilligan agrees that it could create a lock-in effect. If you sell, you pay tax, if you don’t, you don’t pay tax.

“It’s a tax incentive to never sell – property becomes tightly held.”

There’s some good news for those currently looking to buy; when it does come in, it’s not considered likely to be retrospective, so those who bought prior to the five-year extension most likely won’t be affected.

Capital Gains Tax (CGT)

When it comes to CGT, the Working Tax Group appointed by the Government hopes to be reporting by the end of the year and if it suggests implementing a CGT, this will not take effect until the 2021 tax year.

“I think the Working Tax Group will say it’s a good idea,” says Gilligan.

“I think [forming the Working Tax Group] is a very ethical, very transparent way of doing it.”

Gilligan says typically, in other OECD countries, capital gains tax is at your marginal tax rate (33%) and affects all types of gains, from property to vehicles to artwork. So, introducing it here will mean everything comes into that net.

When it comes to property, there are further considerations.

“Capital gains tax goes hand in hand with stamp duty. Stamp duty is a buyer’s tax – capital gains tax is a seller’s tax.

“The buyer has to pay typically 5% of the purchase price … and you can’t borrow it, you have to have cash for it – and that would be quite a shock to the market – it’s quite recessionary in that regard.”

Gilligan also warns against the “mansion effect” CGT can promote.

‘If you’ve got lots of property investors taking property to the market you would think that prices might drop’ MARK WITHERS

The “main home exemption” means people pour their money into their own home because they know that, if they make them beautiful and large, the gains that come out of the family home are not taxable, creating “a very positive skewing bias towards mansions”.

What Do I Need To Know?

The day a CGT comes in is usually called the V-day or valuation day when all the housing stock is given a value.

If you don’t go and get your own valuation it’ll be the Government valuation or current valuation, says Gilligan.

“So, if the CV on your property is $1,000,000 but the market value is $1,700,000 then it’s very important to get a market valuation so that the cost basis for your capital gains tax, when you sell, is fixed at the higher [value].”

If this system is brought in, Gilligan says it’ll be crucial to know the value of your property.