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The Government is considering axing the scheme where landlords and property investors claim losses against their taxes - a move which could see tenants lose their homes if owners sell.
Finance Minister Michael Cullen told Parliament he was considering the move as part of the Government's wider concerns about monetary policy.
"One option which emerged as having a potential positive impact was the ring-fencing of losses from residential property investment.
"This, of course, would not be new. It was the law in New Zealand before 1991," Dr Cullen said. The Government had not yet decided to implement the changes and was looking for support from National on the issue.
Dr Cullen said senior National MPs differed over the merits of changes to the tax regime for rental properties, but it was worth investigating further.
"Since the repeal of those provisions in 1991 there was very, very substantial growth in losses which substantially outgrew the actual rental income and that clearly pointed to heavy [debt] gearing for the purchase of rental property, contributing probably to heating of the housing market."
Bryan Thomson, head of the largest real estate agency, Harcourts, said he feared the loss of tax deductions because of the impact on the private rental sector.
Around 400,000 houses and flats worth $140 billion are rented to 1.2 million tenants.
Mr Thomson said that as home affordability worsened and renting became more common, more people might depend on the state for a roof over their heads.
Landlords were already finding themselves financially stretched with interest rates in double-digit territory. Mr Thomson said the loss of tax breaks would be a further blow.
"Landlords could automatically sell properties and the outcome could be that the Government would have to construct a lot more state houses," he said.
But he believed the loss of tax breaks was so far-fetched it would not get any further than talk.
Instead, he called for the Government to tackle inflation by targeting the farming sector, saying rising Fonterra payments were a significant factor in consumer spending and inflation.
"Blimmin' dairy farmers - maybe the Government needs to legislate on the number of cows."
The Reserve Bank and Treasury have been pushing for tougher tax rules for more than a year.
Bernard Hodgetts, acting economics head at the Reserve Bank, prepared a paper for this month's parliamentary select committee on housing affordability, pushing for precisely this.
He blamed current tax laws for fuelling the housing market.
"It appears that tax policy has been a factor behind the rise in the proportion of residential properties being used for investment purposes, which in turn has been a contributing factor on the rise in house demand," he wrote in the bank's submission.
He reminded the select committee that last year, Treasury and the bank had explored the problem and called for greater enforcement of tax rules on rental properties.
Last month's Budget assigned an extra $14 million for Inland Revenue to catch landlords who broke the law by deliberately evading paying tax they owed.
But many people in the sector saw this sum as laughable because the scale of the tax evasion problem in the rental sector is so huge.
National's finance spokesman, Bill English, said Inland Revenue officials had told MPs there was no tax advantage for rental properties over other investment types.
In fact, it was worse because it attracted a capital gains tax in some instances.
Dr Cullen said Mr English was wrong and the IRD had been talking only about capital gains issues between different asset classes.
The minister said property had a tax advantage because people could borrow heavily and then claim losses.
"Housing purchasing is one of the very few areas that you can actually borrow 100 per cent of the purchase price with no prospect of actually a return on equity except in terms of the capital gain at the end of the process."
John Shewan, chairman of PricewaterhouseCoopers, said last night: "I think it would be a serious mistake to jump opportunistically at what would be an ad hoc measure that is unjustified.
"Sir Robert Muldoon tried this back in the early 1980s. It was a devastating failure ... It would be contrary to good tax policy to delete one particular kind of investment and ring-fence losses."
