Fred Too
You have no doubt noticed that house prices are rocketing away. A million dollars won’t get you much at all in Wellington and Auckland. Prices have reached unbelievably high levels in nearly all our other cities too.
The relentless climb in house prices is increasing disparity as property owners get wealthier while non-owners get left behind. Young people must also be finding it increasingly difficult to get onto the property ladder.
A big factor contributing to the current high demand for rental properties is the very low interest rates for both lending and borrowing. Money in the bank is now earning next to no interest. A term deposit will pay you just 1% interest at the very most, and then it is taxed at your marginal rate. So bank deposits are not even keeping up with our current low inflation rate. No wonder many of you with money to invest are buying rental properties.
The Labour government has backed itself into a corner on the issue of high house prices. The Prime Minister and other Ministers have told us for several years now how they are committed to at least having house prices not rise further. Yet they have also promised to not raise taxes, to not introduce a capital gains tax, and to not introduce a Greens style wealth tax or any other new tax. The only exception is their higher income tax rate for those earning over $180,000.
Labour have promised to get rid of the RMA and replace it with new planning legislation that should help ease house prices by speeding up new developments. However, repealing the RMA and replacing it with two new acts as promised – one to govern planning and one to protect the environment – will take close to three years. Even then, there is a risk that the reforms won’t achieve the intended aims. It is inevitable that lobby groups will stifle the streamlining of processes and cloud attempts at creating clarity.
I wonder if the government could tinker with the tax system to increase the tax on landlords without breaking any promises?
Ensuring that rental properties always generate a reasonable amount of taxable income should deter landlords from paying ridiculously high prices for them. This could be achieved by imposing an alternative minimum income tax on rental property. Another option would be to remove the deductibility of interest for rental property purchases. Neither of these changes could technically be classed as increasing tax rates or introducing a new tax.
A deemed-return tax was considered by the Cullen tax review and seemed to be their second choice after a capital gains tax. With only a slight modification, the deemed-return tax could be turned into an alternative minimum income tax on residential rental property. Landlords would continue to calculate the tax liability on their rental property as normal, but that tax liability would apply only if the deemed-return calculation didn’t come up with a higher liability.
The Cullen tax review gave a handy example of how a deemed-return minimum income tax could work. Tina owns a residential rental investment property worth $1,000,000 (the latest RV could be used). The property is funded with $300,000 of debt, implying equity of $700,000. Tina pays the current top marginal tax rate of 33%. The deemed rate of return is 3.5%. Tina would therefore owe income tax for the year of at least $8,085 (i.e. $700,000 x 3.5% x 33%). If the normal tax calculation based on the rent received less expenses yielded a higher liability then that would apply instead.
Alternatively, to not reward borrowing, the deemed-return minimum income tax calculation could use a lower rate of return but apply it to the full capital value of the rental property (regardless of the value of any loan on it). For example, a deemed rate of return of 2.5% would mean Tina would owe income tax for the year of at least $8,250 (i.e. $1,000,000 x 2.5% x 33%). However, Ron, a more aggressive investor, who borrowed $700,000 to purchase the same value property, so had equity of only $300,000, would also have the same minimum income tax bill of $8,250. Ron would have had a minimum liability of only $3,465 if the formula suggested by the Cullen tax review applied (i.e. $300,000 x 3.5% x 33%).
Removing the deductibility of interest is the other option to raise the minimum amount of tax paid by landlords. If we take the example of Ron again and assume his mortgage interest rate is 3.5% (currently the rate for a five year fixed term), he could not deduct his $24,500 of interest. If we assume Ron otherwise had net rental income of $550 a week, his income tax payable for the year would be $9,438 (i.e. $550 x 52 x 33%) rather than $1,353 when interest is deductible (i.e. [$28,600 – $24,500] x 33%).
In conclusion, the Labour government has very few options open to it that might quickly dampen the rapid rise in house prices, given the promises it has made. However, changes to the tax system to tax landlords more without raising tax rates or introducing a new tax are possible. A minimum income tax for landlords based on a deemed-return calculation could be introduced. Alternatively, landlords could have interest deductibility removed.
To ensure whichever of these tax changes chosen isn’t too traumatic it could apply only to new purchases of rental properties, or be eased in gradually. The deemed rate of return could start low and be gradually raised. Alternatively, the portion of interest expense that is non-deductible could start low and be gradually raised to 100%.
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