Susan St John is Associate Professor of Economics at the University of Auckland Business School and Director of the Retirement Policy and Research Centre.

Ideasroom

Landlords, save your crocodile tears

True to pre-election policies, Labour looks set to introduce a ring-fencing rule to stop property investors offsetting losses from investment property against other income.

But this is just tinkering: losses from one property can still be offset against others that make profits, or carried forward and written off eventually. What is required is a thorough overhaul of the taxation of all housing. Will the Tax Working Group will be bold enough?

Unsurprisingly the New Zealand Property Investors’ Federation claims there will be “no good outcome from ring-fencing losses”.

Ring-fencing losses is supposed to “level the playing field between property investors and home buyers” says Labour’s Stuart Nash. The property investors’ federation correctly counters that once imputed rental is included for homeowners, “Rental property buyers do not have an advantage over home buyers and the playing field does not need levelling.”

Fair enough. But the problem, they then go on to argue, is that ring-fencing will cause the rental supply to fall, increasing rental prices and overcrowding. Here is the example they give:

A New Zealand Property Investors’ Federation study into the cost of providing the average NZ home as a rental shows it currently costs $5,500 a year after all costs are paid, even with recent rental price increases and a cash deposit of over $50,000. If the plan to ring-fence losses is introduced, this cost will increase to $9,000. This is an extra $67 per week.

The burning question is why would someone with $50,000 buy a $550,000 house with a $500,000 mortgage, at say five percent, producing an interest cost of $25,000, that with rates and other costs make a $5,500 loss? It makes no sense without an expectation of capital gain.

But don’t hold your breath for a sensible capital gains tax. Even if one could be designed, it will be years coming in and then only capture capital gains from the date of its introduction. In the example of the ‘poor’ landlord above, the tax-free capital gain over the next few years may be very lucrative indeed.

Please landlords and home owners – no crocodile tears. If you can’t make at least as much taxable income as you could if you put the money in the bank, then the taxpayer should not be subsidising you.

The Tax Working Group should look carefully at the 2001Tax Review and explore a tax on net equity approach. Based on the principle that all income-earning assets should be treated equally, the $50,000 net equity could be treated the same as if the investor had placed that money on deposit at the bank. At five percent this creates a taxable annual income of $2,500, a rather modest sum. But with a non-deductible $25,000 interest bill to pay and with other costs, the investment is clearly not worth it at current rents.

And it won’t get better, because net equity increases each year as the value of the property goes up. Suppose in five years the value has doubled to $1,100,000 so that net equity becomes $1,050,000. Taxable income should be $52,500 regardless of rental income and regardless of other costs.

Unwisely Labour has taken the owner-occupied home off the Tax Working Group’s table. The danger of that decision is that elaborate owner-occupied housing becomes even more attractive. It would be better to allow a generous exemption for a home, say up to say $1 million net equity per person. That way the $20 million owner-occupied mansions will be included, but modest homes fall outside the net.

Under the net equity approach, landlords won’t be subsidised to speculate, and some may withdraw from this market. There would be no more fancy tax accountants needed to manufacture losses. No more fiddling the repairs and maintenance costs, crossing the fuzzy line between capital enhancement and write-offs for depreciation and replacements. Moreover, as past capital gains are captured in the net equity approach, the wealth gap may narrow at last rather than continue to grow exponentially.

A net equity approach could leave more houses for genuine first home buyers. But if we want to contain the biggest housing bubble in the western world, a price correction is also required. The best we can hope for is gradual adjustment, not a precipitous fall such as experienced in Ireland after their strong bubble 10 years ago. This means a carefully-managed transition to the net equity approach will be required.

Please landlords and home owners – no crocodile tears. If you can’t make at least as much taxable income as you could if you put the money in the bank, then the taxpayer should not be subsidising you.