Landlords fret over possible tax hit

Landlord Lee Whiley says he wonders whether he can compensate for lost income after any big tax changes. Photo / Glenn Jeffrey

Lee Whiley's tenants nicknamed him the Bond Street Baron.

Owning four houses in the popular Arch Hill thoroughfare near Eden Park, including two neighbouring houses, the lighthearted landlord is happily spending the summer on DIY after selling his bike business.

"I'm fulltime working on my properties, improving them. They're suffering from what's nicely termed delayed maintenance," says the soccer fan, one-time environmental scientist and ex-Auckland Regional Council staffer.

His classic villas with distinctive verandas, stained glass windows and wood floors lap up attention and he bought the four in one street after finding that part of town to be central and relatively cheap, a magnet to students and new workforce entrants.

Whiley says his role as a landlord has morphed into a fulltime position as he focuses on re-tenanting one empty place and spending time and money on the others.

And of course there's the tax benefits to think about, too.

"Any money I spend on the properties, I claim back from IRD. I'd spend about $5000 a year on each place, over and above interest on the mortgages, rates, insurance and the lawn-mowing contractor. So I usually don't end up paying tax."

Whiley is one of about 180,000 Kiwi landlords with about $213 billion invested in the sector who could be in for a rude awakening come Tuesday.

The Budget will not be out until May 20 but a better idea about the Government's tax plans could emerge next week, says Finance Minister Bill English.

Prime Minister John Key will outline the Government's thinking when he opens the parliamentary year and English promised the Government would "tilt the economy towards exports and investment and away from consumption and borrowing".

Revenue Minister Peter Dunne put the boot firmly into landlords last month when he said some asset-rich, cash-poor investors were rorting the system to the extent that they claimed Working for Families benefits.

In what one commentator referred to as an "ah-ha!" moment, Inland Revenue and Treasury found the $213 billion invested in residential rental property generated losses for tax purposes of more than $500 million in 2008, costing taxpayers $150 million.

The group suggested big changes aimed at landlords, identifying "gaps in the current system where income in the broadest sense is being derived and systematically under-taxed such as returns from residential rental properties".

"There is a major hole in the tax base for the taxation of capital which is manifest, for example, in high investment and low taxable returns in the property market. The tax system biases investment in favour of rental property investment. One of the consequences has been that in recent years there has been a steady decline in taxable income declared by rental property investment and indeed there have been substantial net tax revenue losses," the group's report said.

It cited tax claims by loss-attributing qualifying companies, entities with special tax status enabling landlords' losses to be offset against personal income for determining their tax liability.

Geoff Nightingale, a PricewaterhouseCoopers partner and member of the group, this week said recommendations were not aimed at beating up landlords and he had certainly heard their loud complaints.

"That's a valid reaction and it's reasonable for anyone who's going to be taxed differently or more than before to react quite strongly. But you have to see the proposals in the wider context. It's hard for landlords as an industry to say they are properly taxed because they are not.

"The industry got a tax subsidy of about $150 million in 2008 and about $50 million in 2007. So in the last two or three years, the industry has not paid tax. In my view, that has to change.

"The tax subsidy landlords are getting is being made up for by middle and higher-earning PAYE taxpayers incurring the cost. The system is producing an unbalanced result and it has to change, whether or not the Risk Free Rate of Return is the right option, it has to change," Nightingale said.

The way Whiley calculates the tax changes, half his income could vanish.

"Changes to depreciation could cost me $20,000 to $30,000 a year. Land tax - quite unjustified in my view, draconian, like something from England in the Middle Ages - could cost me $10,000 a year. But depreciation on buildings is the difference between me paying tax and not paying tax. Why should we be penalised for investing in property? We're providing a social service," Whiley said.

And while his land is appreciating in value, the old houses are most certainly depreciating, requiring big upkeep and maintenance.

The financial outlook is not softened by what he sees as his inability to push rents up much.

Whiley remembers shifting to Auckland in 1986, paying a weekly $100 for a room in a flat, only $50 less than he can now charge.

Renting out his four to six-bedroom houses at $600 to $900 a week, he calculates he is getting about $150 a week a room. So he wonders whether he can compensate for lost income after any big tax changes.

Whiley and his ilk feel like political scapegoats. "Landlords are held up as villains and we're an easy target because we're only a small percentage of the population."

The Tax Working Group was glowing about introducing the Risk Free Rate of Return method for property as a means of reducing the existing investment bias towards residential property.

This would mean the introduction of a new tax levied annually using an assumed risk-free rate of return, for example 4 per cent, on the amount of equity the owner has in property, regardless of the actual return.

The 4 per cent would be taxed at the landlord's marginal rate.

Property Investors' Federation vice-president Andrew King is smarting about the suggestions.

"The often-mentioned tax loss of $150 million occurred in 2008 when interest rates were at their peak. With lower interest rates, rental property will once again contribute to the tax take again in future years. If a rental property goes up in value, any depreciation claimed is clawed back.

"No one mentions depreciation clawback offsetting depreciation claims. It would be extremely bad if rental property was so adversely affected based on incorrect information. People have totally the wrong idea."

Dean Letfus - landlord, property mentor and seminar presenter - is more scathing.

"This is sheer deficit-driven lunacy. New Zealand is a very small fragile ecosystem. Killing off all the landlords will devastate a whole generation. People will literally have nowhere to live and the Government will bankrupt itself trying to house them. New Zealand remains housed thanks to Kiwis being willing to risk investing in heavily negatively geared property with the hope of eventual capital gain. Depreciation makes that investment possible.

"Attacking it will put many thousands of people in immediate financial stress and bankrupt many, cause seasoned investors to move into other asset classes and cause mums and dads to keep their money in the bank - the most non-productive of all investments. The end result is a slam dunk: chronic housing shortage and massive rental increases.

"Providing the Government does not make the legislation retrospective and applies this lunacy to only properties bought after the law change then at least we can all sell and move our money offshore or leave the country. I personally would sell up, leaving 50 tenants with a problem, and start investing in Australia more which actually wants to attract investors," Letfus says. "I can't count how many friends and clients have gone bankrupt under the current 'privileged' regime. God help us all if they enact this 'fairer' system."

Karen Farrell, an Auckland landlord, aims to retain tenants for years. She recalls extending compassion to one tenant who got a couple of weeks behind with the rent. Landlords like her are responsible people who work hard to achieve goals, she says.

"We're knuckling down, working towards our retirement and also to be able to give our kids a helping hand into their first houses as well. Yes, the tax system does help us, particularly being able to claim deductions on tax from the mortgages. But the Government has to be careful not to frighten private residential property investors into getting out of the business. That's just going to create even more of a shortage of houses and Housing NZ can't supply enough to meet the demand," Farrell says.

For Farrell, big rewards came when a Christmas card arrived from a tenant. "She was thanking me for enabling her to step back into the world. People need a little understanding. For me, it was just a small rent shortage but for her, it had big repercussions and having to shift out would have been catastrophic.

"It's my job as a landlord to look after what is their home."

GROUND TREMORS

Tax working group real estate revenue-raising options

Indicative annual revenue:

* New 0.5 per cent land tax regime on all land
Indicative annual revenue: $2.3b

* Denying building depreciation
Indicative annual revenue: $1.3b

* Risk Free Rate of Return on rental housing
Indicative annual revenue: $500m-$900m

Source: Victoria University Tax Working Group