Finance Minister Bill English presented the 2010 Budget in Parliament last week. Ever since the Tax Working Group’s recommendations were made public, uncertainty was created in the property market about expected changes to tax treatment of property losses and resultant impact on property prices. Initial speculation as to imposition of land tax and capital gains tax was put to rest by the Prime Minister a couple of months ago, still there were fears that property losses will be ring fenced and restrictions may be laid down as to how much rental loss can be claimed against other income.
But now after the budget has been presented, all speculations have been put to rest. As was widely expected, property investors will not able to claim depreciation on those buildings whose expected life is more than 50 years.
Simply to say, residential property investors will not be able to claim depreciation on buildings, though they will be able to claim depreciation on chattels as usual. Here it is worth mentioning that as per present rules, one can claim depreciation on buildings, but when the property is sold at more than written down value of the property, the depreciation is considered to be recovered and forms part of taxable income. An example can be summarized in the following table. In this example, the original purchase price of building was $200,000 and depreciation claimed till date is $10,000.
It means the book value of the building is $190,000. Now if the building is sold for less than $190,000, the depreciation recovered is nil. If the building is sold for more than $190,000, the depreciation recovered will be excess of sales price over $190,000 subject to maximum of $10,000. The difference over and above $200,000 is capital gain.
I II III
Purchase price of building ( A) $200000 $200000 200000
Depreciation claimed till date (B) $10000 $10000 $10000
Written Down value (C)=(A)-(B) $190000 $190000 $190000
Sales Price (D) Say $188000 $195000 $210000
Depreciation recovered 0 $5000 $10000
(D)-(C) or 0 if (D)-(C) is negative
but subject to maximum of depreciation
claimed which is $10000 in this case
So, in the above scenario, if the building is sold for $200,000 or more, the depreciation recovered will be added to taxable income. It means tax advantage to property investor is not real as long as the property is sold at more than cost price. Depreciation only helps cash flow during the period of time the property is held as an investment property. In fact, there are few property investors who elect not to claim depreciation as they don’t like to claim tax benefits initially and pay back later.
The second major change regarding taxation of property investors announced is calculation of family tax credits. There are few people who become eligible for family tax credits when rental property loss is deducted from their taxable income, means their taxable income goes lower. There will be very few property investors who fall under this category.
In my opinion, none of above two changes will impact property market. Majority of people buy investment properties for capital appreciation, tax benefits being bonus. Real estate is considered the safest investment by many. They prefer it over other forms of investment.
The only thing that can have adverse impact on property market in short term will be rising interest rates. Considering future inflation expectations, Reserve bank will start raising the rates soon. The future direction of property prices will be determined by economic conditions and immigration. New Zealand economy is expected to do well in coming years; still investors are advised to invest wisely and not to take unnecessary risks.
Ravi Mehta is an Auckland based Financial Advisor and can be contacted on ravi.mehta@pfsl.co.nz. A disclosure statement as required under Securities Act 1988 is freely available on request.