By David Chaston

There is a lot of talk about taxing capital gains "earned" by owning residential rental property.

This article is an attempt to put an approximate value on those gains, and the amount of tax that may be available to a government.

In the year to June 2017, there were 1,842,900 private dwellings in New Zealand. Of them, 1,160,500 were owner-occupied and 682,400 were rentals.

Based on the 2013, 2006 and 2001 census data, and other Statistics NZ information, we are able to build an approximate estimate of how those dwelling numbers have grown since 2002, and how they have been distributed between owner-occupiers and renters, nationally, and for the main centres. (To be fair, some of this involves estimates based on other estimates, so there is likely to be inaccuracy involved. But the data is the best we can do with what is available.)

We also know how many real estate sales transactions have happened over this period. And we know the median prices. This data is from the Real Estate Institute of New Zealand.

In addition, from the same source, we have some unique lower quartile data available that can help us get a fix on the end of the market where you are more likely to find rented properties. That market is also where first home buyers start out, so it is not only investors in residential rental property operating there. (It is only very recently, from the Reserve Bank, that we have been getting insights into first home buyer activity. But none of that Reserve Bank data can yet be matched up reliably with the REINZ data).

How much capital gain realised & how much tax avoided?

Because we know this detail, we wondered if we could estimate how much capital gain has been realised in these transactions. And can we therefore get a rough estimate of how much income tax has been avoided by investors who hold rentals?

Having built the relevant data, possibly we can.

This is what it shows: In the year to June 2017, if the average holding time for the lower quartile sales was 10 years (some will be longer, some shorter), then the 10 year capital gain on those sales was about $1.8 billion. Of that, $1.2 billion of those gains were in Auckland, $200 million were in the Waikato, $100 million were in the Bay of Plenty, $125 million were in Wellington, and only $30 million were in Canterbury.

That means that for lower quartile sales only, about $600 million of tax was avoided using this exemption for capital gains, of which a bit less than $400 million stemmed from realised transactions in Auckland.

But the numbers are very much larger for owner-occupiers. For the same timeframe (the year to June 2017) owner-occupiers who sold realised $7.9 billion in gains, avoiding more than $2.6 billion in taxes (that would otherwise have applied if the gains were for anything else). In Auckland the gain was $4.8 billion (avoiding more than $1.5 billion in tax), in the Waikato, the gain was nearly $900 million ($300 million), Lesser amounts are involved in the Bay of Plenty, Wellington, and Canterbury.

Taxing realised real estate gains could have given a 10% across the board income tax cut

Just for perspective, personal income tax in the same period amounted to $29 billion. So the avoided tax for owner-occupiers of $2.6 billion, plus that for owners of rental property of $600 million, represents more than 10% of the income tax taken from individuals. Taxing realised real estate gains could have given a 10% across the board income tax cut.

Or that $3.2 billion could have eliminated income tax for everyone who had annual taxable incomes of $30,000 and below, benefiting almost 1.5 million low income citizens.

There were just 81,000 real estate transactions in that period. Our data shows that 5.3% of all owner-occupied housing sold in the year to June 2017, while only 2.9% of the stock of rented housing sold in the same year. Landlords are only half as likely to sell than owner-occupiers.

A: Ten year capital gains from lower-quartile realised transactions

In year to June NZL AKL WAI BOP WGN CBY NZ$ bln $ $ $ $ $ $ 2002 1.687 1.007 0.110 0.116 0.231 0.070 2003 2.475 1.410 0.183 0.192 0.286 0.179 2004 2.687 1.441 0.218 0.213 0.310 0.261 2005 2.882 1.320 0.272 0.235 0.327 0.346 2006 3.099 1.157 0.293 0.169 0.414 0.419 2007 3.980 1.582 0.325 0.229 0.473 0.525 2008 2.195 0.747 0.155 0.102 0.258 0.324 2009 1.399 0.401 0.087 0.073 0.123 0.243 2010 2.087 0.874 0.146 0.091 0.196 0.321 2011 1.503 0.745 0.093 0.073 0.147 0.155 2012 1.651 0.784 0.117 0.058 0.122 0.283 2013 1.709 1.038 0.091 0.016 0.141 0.254 2014 1.148 0.889 0.013 (0.029) 0.016 0.155 2015 2.222 1.710 0.055 0.038 0.066 0.151 2016 3.544 2.201 0.433 0.284 0.119 0.193 2017 1.821 1.194 0.202 0.103 0.126 0.030 NOTE: These are only estimates, based on lower quartile prices, actual sales volumes, and Census data for rented/owner splits. The numbers above may look 'accurate' but are derived by calculation and should be treated as a rough guide only.

B: Ten year capital gains from owner-occupied realised transactions

In year to June NZL AKL WAI BOP WGN CBY NZ$ bln $ $ $ $ $ $ 2002 7.802 4.453 0.572 0.526 1.175 0.365 2003 11.461 6.134 0.812 0.860 1.469 0.795 2004 13.401 6.364 1.078 1.114 1.586 1.156 2005 14.008 5.677 1.266 1.142 1.587 1.419 2006 13.845 4.649 1.297 0.823 1.815 1.558 2007 17.062 6.978 1.357 1.073 1.995 1.946 2008 9.322 3.381 0.678 0.473 1.047 1.257 2009 5.587 1.986 0.395 0.325 0.441 0.976 2010 8.938 4.055 0.633 0.385 0.798 1.314 2011 6.734 3.312 0.387 0.349 0.597 0.587 2012 6.925 3.701 0.438 0.227 0.434 1.115 2013 7.591 5.140 0.352 0.009 0.466 0.950 2014 4.892 4.172 (0.048) (0.283) (0.100) 0.707 2015 9.895 7.767 0.151 0.092 0.296 0.690 2016 16.157 9.783 1.908 1.410 0.688 0.900 2017 7.893 4.839 0.890 0.598 0.583 0.265 NOTE: These are only estimates, based on median prices, actual sales volumes, and Census data for rented/owner splits. The numbers above may look 'accurate' but are derived by calculation and should be treated as a rough guide only.

Interestingly, the transactions to June 2017 now encompass a period where the dollar value of the gains being recorded are falling. Not only are prices past their peak, but transaction volumes are declining too.

If these real estate gains were taxed in this way in the year to June 2016 when both the volumes were much higher and the ten year value gains were also higher, the amounts of tax avoided is much, much higher. In the lower quartile market, the gains were double the 2017 levels. In the owner-occupied market the level was similarly doubly higher. The tax avoided was probably in the order of $6.5 billion.

The nature of the real estate cycles means that any tax on these realised capital gains will be volatile, and therefore may not be suitable as a substitute for regular income tax adjustment. A doubling (or halving) of these tax flows will be very messy for Government budgeting. But they might help in other ways, like paying down Government debt, making some big one-off capital expenditures, or bolstering the NZ Super Fund.

Just a profit like any other

Those choices are however not on the table so long as we regard gains from housing values as something 'special'. They aren't. They are just a profit like any other and should be taxed like any other profit. All gains should be treated equally in my view; the income/capital distinction is arbitrary and hardly justifiable. (On the other hand, I do think the realised/unrealised distinction is relevant. We should not be taxing theoretical paper gains of any sort. But those who favour an assets tax might disagree).

As for a homeowner exemption, other than a sop to voter greed, I can't see the justification for that either.

Treat all gains (and losses) equally in tax law.

(Tax law also makes a distinction between "earned" and "unearned" income. Capital gains are certainly "unearned" having basically just fallen out of the sky. But this is another distinction that is pretty artificial and seems hard to justify).