Playing the mortgage game

Q. I'm a 28-year-old single woman and I bought a rental property in January 2004 for which I have a $149,500 mortgage.

The mortgage is interest-only, fixed at 7.3 per cent until January 2006. The rent pays for all the annual outgoings.

My plan is to keep renewing a fixed-rate, interest-only mortgage and, at the end of each term, pay a lump sum off the borrowed amount before re-fixing.

This will give me flexibility on how much I can afford to put towards paying it off each term and won't tie me to high principal and interest repayments every fortnight. I can't afford to live in the property on my own which is why I'm renting it out.

I'm leaving my job in September to go travelling and will get a superannuation payout of about $18,000 which I have been contributing to. I have two questions:

* Should I put all the superannuation money on the mortgage when I re-fix it next year or should I put some into another super fund?

* Do you think my plan of paying lump sums instead of principal and interest repayments is a good idea?

A. When you say you can't afford to live in your property, I assume that means you are renting a smaller or less desirable place for yourself.

There can't be all that many landlords doing that. But good on you. Like the 18-year-old apprentice in this column two weeks ago, you're another young person who seems likely to end up rich!

In answer to your first question, I think I would favour putting all the super money into the mortgage.

As I said last week, repaying a mortgage is the equivalent of making an investment that earns the same as the mortgage interest rate, after taxes.

It's not easy to get such a high return year after year. What's more, repaying a mortgage is risk free. So it's usually better to repay a mortgage than to invest.

In your case, though, there's a significant difference. With a rental property, the mortgage interest is tax deductible.

After tax, then, your interest is costing you about 5.8 per cent if you are in the 21 per cent tax bracket; or 4.9 per cent in the 33 per cent bracket; or 4.5 per cent in the 39 per cent bracket.

An investment in, say, a well-diversified low-fee share fund might well do better than that. And it spreads your money beyond just property.

Note, though, that I say "might". You would certainly be taking more risk than if you repay the mortgage.

Given that you will soon be running your property from overseas - which in itself is risky, even if you hire a manager - I would get that mortgage down a bit.

You never know what the future holds. You might decide to buy property overseas and sell here, perhaps when our property market is in the doldrums. If so, the lower your mortgage, the better.

On to your second question. Your plan seems pretty clever to me. By making lump-sum payments at the end of each fixed-rate term, you avoid repayment penalties.

Also, as you say, interest-only payments are a little lower.

That makes it less likely you'll have a shortfall if interest or other expenses rise or you have to reduce your rent or have a period without tenants - a problem you don't want to face from the other side of the world.

And given that you won't know how much you will be able to put into principal repayments while abroad, the flexibility of your plan is excellent.

I wouldn't recommend it for everyone. Most people like the discipline of having to regularly repay their mortgage principal. Otherwise, they might just spend the money. But you sound like someone who is pretty disciplined financially. Go for it.

* * *

Q. Just reading your column last week and I, for one, do not mind a bit conversing by phone with the IRD.

However, you might point out that it requires extraordinary tenacity to do so. After the inevitable "our operators are busy", the IRD have a twist of their own. Another recorded message states they are overloaded and please ring again.

At least they don't lie and say: "Your call is important to us." I have rung many times this week and been singularly unsuccessful.

It is all very well for people like you, who no doubt have the direct dial number of their own pet IRD person. Wish me luck for tomorrow.

A. Sure. Good luck. And, if it helps, Inland Revenue says it "would like to apologise to anybody who is having to wait after calling us".

To improve your luck, avoid ringing at the busiest times - on Mondays or around the middle of any day. The call centres are open from 8am until 8pm Monday to Friday and on Saturdays from 9am to 1pm.

The IRD says it handles about four million calls a year and this is its busiest time of year. "For those wanting simply to request or confirm personal tax summaries details or access stationery, we recommend they contact us through our automated service, INFOexpress. This can be accessed directly on (0800 257 773)."

You could also try the recently redesigned www.ird.govt.nz, which the department says is now more user-friendly.

The site offers lots of information as well as forms, stationery and tax returns, and calculators for tax and other entitlements. "People can also view their account information and file tax returns online."

I might add that I do have a "pet IRD person" who helps with this column and the like - although thus far she hasn't wagged her tail or barked. But if I want to know anything about my own taxes, I queue up with everyone else.

* * *

Q. I have also been shown "the new way" of depreciating rental property - with items such as wiring, plumbing and partitions depreciated faster than the building itself - which gave me misgivings.

If the IRD does rule against this practice are they able to just ask for the difference to be paid or could they also (if they wish) impose penalties? If they could impose penalties, how severe might they be?

If you instructed your accountant to depreciate the old way and IRD subsequently ruled in favour of the new way, could you go back and re-claim the new way?

A. It's nail-biting time.

The IRD says that, if a taxpayer over-claims depreciation deductions, not only would the difference have to be paid, but "use of money interest is likely to be payable".

"In addition, shortfall penalties may also be imposed by Inland Revenue. This would be considered on a case-by-case basis."

Interest is charged at 13.08 per cent a year. And shortfall penalties range from 20 to 150 per cent of the extra tax owed. Ouch.

On your second question, the spokesperson said: "Inland Revenue is reviewing the correct treatment for depreciating parts of a building.

"We are not in a position to comment on whether the commissioner would amend a taxpayer's previous years' assessments when the taxpayer had not claimed at higher rates, but who subsequently seeks to have those years adjusted."

But wait, I thought when I read that, there must be a general rule about this. So I asked the spokesperson: "If someone realises they have not taken deductions as big as they are entitled to in a past tax return, can they re-file and get a refund?"

Back came the reply: "A taxpayer cannot re-file a return - however, they can seek an amendment to a previous assessment.

"Requests by taxpayers for IRD to amend a previous year's assessment are considered on a case-by-case basis in accordance with IRD's Standard Practice Statement INV-510, Requests to amend assessments.

"There are restrictions on how long after a tax year a refund can be issued by the commissioner."

That's as far as we're going to get. So where does it leave you?

Given that the IRD's present view is that people who own buildings must depreciate wiring, plumbing and so on at the same rate as the building, I would stick to that if I were you. Those penalties are tough.

Perhaps you'll just have to settle for superb tax-free capital gains recently and a still generous depreciation regime.