Go with your heart if it's all the same

Q I live in Auckland, earn $60,000 a year and currently live in rental accommodation. I qualify for a $232,500 mortgage with my $12,500 (5 per cent) deposit.

Looking forward for the next 20 to 25 years, I am unsure which path to take. Should I pay off a large mortgage that will amount to approximately $430 a week (currently), including land rates and house insurance, or save the difference between my $330 a week rent and the $430?

I can't find a property to buy for $245,000 in the suburb in which I now rent, and my basic calculations show that if I continue to save I will have nearly as much after 25 years as if I pay off a mortgage with its huge interest component.

At $430 a week, I can't see myself paying off the mortgage earlier to reduce the interest without dramatically affecting my lifestyle and, as life is short, I believe I am better to enjoy it.

Can you check that I'm not missing something and provide some typical outcomes of renting and saving versus mortgage payments over 20 to 25 years?

I realise there is a certain amount of guesswork and crystal ball gazing involved. But based on historical trends over the past 20 years how would I fare either way?



A. I don't know, and nor does anyone else.

It's impossible to even predict how much your savings of $100 a week will grow to.

It depends partly on your risk tolerance, and hence what investments you go in to, but also on how well those investments perform.

And we've also got to predict how fast house values and rents will grow, and what will happen to mortgage interest rates.

Other unknowns include trends in rates, insurance costs and - an item you seem to have overlooked - home maintenance.

The last three items are not quite so problematic. Presumably, as they rise, they will affect both home ownership and rental costs, as landlords pass on the increases in rent rises.

Still, if there's a shortage of tenants, that passing on might not happen.

I've seen various analyses done. Some use average figures over, say, the past 20 years. But that takes us back to times of high inflation. Those numbers just aren't realistic now.

But if you look back over, say, 10 years, you're not really getting enough data to include a couple of ups and downs in the housing and rental markets.

In any case, the analyses often end up with no clear winner. Home ownership looks better if (insert reasonable assumption A), and renting looks better if (insert reasonable assumption B). Not a lot of help.

You can take some comfort from the fact that economies tend to balance things out, given time.

If, for instance, it became obvious that it was better to own a home than to rent, more people would want to buy homes.

That would push up the price of homes to the point where home ownership no longer seemed such a good deal. Renting would become more popular again.

Over 20 or 25 years, such cycles will probably happen several times. The home owner and renter should, on average, fare similarly.

In the end, then, I think you should choose for non-financial reasons.

You seem to be saying you can't afford to buy as good a place as you're renting. That's a strong point in favour of the status quo.

You might also enjoy being able to move quickly and cheaply, and not having to take responsibility for maintenance.

As long as you've got the discipline to save what you would have spent on the house, renting is not a silly choice.

On the other hand, if you want more security, choice of decoration and pride of ownership, consider home ownership.

Life is, indeed, short. Go for what you want.

Q. I was rather concerned by a statement in your last Herald column that I think must be an error. In answer to a question about tax and depreciation claimed on a property that has been rented but is now owner-occupied, you state: If the property's market value on the first day of the next income year ... is higher than its depreciated value, that difference is added to your taxable income that year.

In the IRD guide IR264 on rental income, re sale of a building, page 23 in the August 1999 version, it says: "The depreciation claimed is included as income."

So in their example, where the difference between adjusted tax value and sale price is $34,000, and the depreciation claimed is $14,000, it is the $14,000 claimed that is added to taxable income, not the $34,000 difference.

In your column, it is the $34,000 that is added to the taxable income. Quite a difference, especially if you return to your home during an Auckland property boom which temporarily inflates the market value, which may later drop again, and which you never actually realise, and where you have claimed the depreciation because before 1997 you had no choice!

So which example is correct: the IRD's one or yours? If it is the IRD's one, your column may be causing unnecessary anxiety to your readers!

A. Oops! You're partly - or perhaps I should say largely - right.

There are three possible scenarios:

* The market value of the property when the landlord moves in is higher than the purchase price, as in your example.

You do, indeed, add the depreciation claimed - which is the difference between the purchase price and the depreciated value - to your taxable income.

* The market value is lower than the purchase price, but higher than the depreciated value.

You would then add the difference between the market and depreciated values to your taxable income, as I said last week.

* The market value is lower than the depreciated value.

In this unusual situation, there would be no clawback.

Given that the first scenario is the most likely, I certainly should have written about it. I can only plead that the rest of the Q&A was about chattels, whose market value almost always drops below purchase price. So I was in that frame of mind.

If I caused anyone unnecessary anxiety, I'm sorry. In no circumstances will a depreciation clawback be more than the total depreciation claimed.

Q. Thanks for chasing up my question with Scott Kerse from PricewaterhouseCoopers.

Unfortunately he's confirmed that the tax situation is just as bad as feared, and that you cannot surf the Knowledge Wave from New Zealand without risking extreme penalties when you have the occasional unpredictable success.

Our hero's income is over the $100,000 level and fluctuates wildly, so last year plus 10 per cent won't work.

All Knowledge Wave surfers who succeed will be in the same situation. It's the nature of the game.

Sales proposals are made and wait on the pleasure of the overseas buyers who may choose the Israelis, the Irish, or the Kiwi.

Sure our hero has an inkling that he might get a cheque for $200,000 or even $500,000, but also he knows that he probably won't (by far the majority of big sales pitches fail.)

Does he then "err on the generous side" and pay $234,000 tax out of his much more likely $100,000 income, just in case, thereby starving his business of capital and guaranteeing failure?

Or does he rely on the IRD to be forgiving when the occasional success occurs?

But please, put away those tissues. Our hero does not expect sympathy (this is New Zealand after all, and he is definitely not one of the socially disadvantaged).

And it really is no problem for him since he can work from anywhere, live anywhere, or retire to the golf course.

It is, however, a serious problem for New Zealand if the Government's Knowledge Wave incubates success that the tax system will then drive overseas, leaving New Zealand with the failures.

All that is required is that you should be able to pay 39 per cent of your income the week you get it, to be free of penalty.

Too much to ask?

A. It shouldn't be.

Scott Kerse points out that Inland Revenue distinguishes between penalties and use-of-money interest. But I don't think many taxpayers care too much whether it's a penalty or interest.

And people with unpredictable incomes are often caught by interest payments.

"We could say, 'Let's change the rules, and, as long as people make an honest attempt to pay tax when they know their level of income, they shouldn't pay use-of-money interest,"' says Kerse.

But then you've created jobs for a thousand tax collectors to judge whether people have been reasonable.

However, he does question the level of the $30,000 threshold.

If our hero had a tax liability for the year of less than $30,000, unless he made an estimate, he wouldn't have to pay use-of-money interest until his terminal tax date, probably April 7, 2004.

He adds that the $30,000 is expected to increase to $35,000 under legislation that was before the House this past week. The change will apply from April 1 next year.

But, he says, further increases in the threshold seem unlikely, as the Government claims that each $5000 increase in the threshold costs $1 million.

That doesn't offer much for our hero if his income rises suddenly from $100,000 to $600,000.

As for hoping the IRD will be forgiving, there's very little scope to remit use-of-money interest, says Kerse. In practice, it's uncommon to have it remitted.

He does note, though, that, another bill before the House, containing tax simplification proposals, would allow taxpayers, like our hero, to pool their provisional tax payments with other taxpayers.

Perhaps if a bunch of Knowledge Wave surfers got together with some self-employed building inspectors, our hero's use-of-money interest problems might be solved.

Failing that, it seems that you're right. Our tax system may well drive some successful entrepreneurs overseas.

Perhaps it would be worth hiring a thousand more tax collectors, if that's what it takes to keep the Knowledge Wave surfers here.

The sort of incomes, and hence tax revenue, that you're talking about ought to finance a quite a few IRDers.

By the way, several other people also responded to the original Q&A on this topic.

Most made similar points to yours. And I decided not to wade too deeply into the business tax pool. It gets pretty murky pretty quickly, and I suspect rather too esoteric for most readers.

All of you, though, have my sympathy.

If it makes you feel any better, Kerse says the Aussie provisional tax system, called Pay As You Go, is broadly the same as ours, although the interest regime isn't quite as tough.

How about lobbying Parliament?

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