In the April edition of this magazine I wrote about Labour confirming they would remove the ability to deduct tax losses from property against other forms of income. Unfortunately they recently made it official at their annual conference.
Andrew Little said that "Labour will close the tax loophole that allows speculators to claim tax payer subsidies for their rental portfolio. It gives them an unfair advantage over Kiwi families".
Point one; It is not a tax loophole, it is a legitimate part of tax law that is available to all businesses and investments. It allows rental prices to be lower than they would without the law, meaning tenants get a better deal.
Point two; Labour's policy is aimed at rental property investors, not speculators. The Bright Line Test was intended to make it crystal clear that these two activities were different and stop speculators passing themselves off as investors'.
Point three; The ability to claim tax losses does not give investors an unfair advantage over Kiwi families.
Unlike homeowners, investors can claim expenses because they receive rental income. Claiming expenses means that we pay tax on the actual net income that we receive. Homeowners don't receive any income to claim expenses against.
Labour forget that it is extremely expensive to provide a rental property, especially when you first buy it. With a 10% cash deposit (so using other assets to make up the other 30% required by the Reserve Bank) and the ability to claim tax losses, an investor will still have to contribute around $6,000 in the first year to provide their tenant with the average NZ home. Without the ability to claim the loss, this figure increases to over $10,000, meaning many investors will have to find extra funds if they are to buy new rental properties.
People have the impression that an investor can pay more for a property because they can claim the extra amount they pay as a tax deduction. So if an investor offers $10,000 more for a property, they think it will only cost them $6,700 after tax. Completely wrong of course.
The ability to claim mortgage loan interest does give the investor a slight advantage, but nothing like many people and the Labour party assume. Using the above additional offer of $10,000, it would cost an extra $500 a year in mortgage interest costs at 5% to pay this amount. As the investor can claim this as a tax deduction, their net cost will be $165 a year less than the home owner.
So a higher bid of $10,000 to buy a property will cost an investor $335 a year rather than $500 for a homeowner. A theoretical advantage yes, but clearly not a significant one compared to the risk of paying too much for a property.
Around a third of rental property owners claim tax losses, however this is at a time when interest rates are at historic lows. What happens when interest rates increase? The removal of building depreciation as a tax deduction has already reduced the number of people able to claim losses against other income.
Clearly Labour are looking for votes rather than looking at the consequences of their policy. If Labour are going to punish rental property owners for keeping rents low then the answer is to increase rental prices. Even those that don't make tax losses should increase their rents to safeguard themselves against future interest rate rises and/or reductions in tenant demand and rental prices.