With book titles such as The Insider's Guide to Real Estate Investing Loopholes, and the governments online brochure IR 435 laying out how to take advantage of Investing in Residential Real Estate, it’s little wonder Mum and Dad investors are taking advantage of what is on offer.
From memory it was approximately 1992 when the Government introduced the concept of “loss attributing qualifying companies”, commonly referred to as an (LAQC) which have been a favoured vehicle of property investors and their advisors ever since.
I remember at the time being a little taken back at the government’s generosity allowing investors to offset losses against personal tax whilst at the same time building tax-free equity.
It’s now 2010, 18 years later and all of a sudden it’s no longer acceptable and the loopholes need to be plugged. A little absurd one might think as they were there from day one.
To those that are running around pointing the gun at property investors I would suggest if you haven’t already done so, put the gun down and read the brochure that was put together by the government to aid investors. IR 435
There really aren’t that many Property Investment Loopholes under the spotlight, (well not that we know of) however the few we do know they are looking at, could be crippling for the ill prepared if implemented in or around May this year (2010)
- Deprecation
- Tax offset against personal income
- Negative Gearing (interest only loans)
Deprecation
Yes I have heard of many examples of people pushing the envelope and fudging the line between depreciation, maintenance and capital gain. This at times can become a very fine line so it is understandable that more work is required, but not certain if it is going to be an end all for property investors.
Sure, some Accountants are outraged as they say their clients made investment decisions based on depreciation, tax right offs, and if they lose those benefits, they could go to the wall. Maybe those Accountant’s are simply putting up a shield in case they are pelted with rocks from disgruntled investors after all, they were the ones that gave the advice.
Tax offset against personal income
I don’t really see how the government could justify axing this benefit as in its current form “isn’t a loophole” as such, however there is a loophole that they are likely to look at.
Most loans for property are set up as an interest only whereas people use equity in their own homes to purchase another borrowing 100% of the purchase price with losses attributed against their personal income.
They don’t pay down the debt and instead rely on capital gain. This is where I believe change is needed. All investment housing loans unless they are speculative should be on principle and interest not interest only.
If this simple change was made less people would get into trouble with over capitalising and the tax system would be fair. Investors would be paying down debt so would be cash flow positive a lot sooner therefore paying tax and personally I don’t see that as a bad thing.
From day one, yes I was in the game when “loss attributing qualifying companies” were floated, but even back then I would tell my clients, “do not make your decision based on the tax benefits treat depreciation and taxes as icing on the cake and use any payout to reduce your personal mortgage”.
You may think some of what I have just said hypercritical, as I have never been an advocate of negative gearing (interest only loans) apart from as a short-term solution.
Not true, as what I would tell clients is this; work out what the difference between interest only, and principle and interest is, and pay the difference off your personal loan which will reduce the amount of interest you pay yet still maximising the tax benefits. Holes like that are likely to be plugged.
For example;
Investment Loan $350,000 @ 6.5% interest only = $1895
$350,000 over 25 years @ 6.5% principal and interest = $2363
So the difference you add to your personal loan $468
Personal Loan $200,000 over 15 years @ 6.6% = $1762 plus $468
This would result in you paying your personal loan off in 10 years and five months and saving something like $38,000 in interest whist maintaining the maximum tax benefits and building untaxed gain at the same time. In addition, if you also used the tax benefits to pay down your personal debt you would be even better off.
Do not be afraid to pay down debt and become cash flow positive. Leave negative gearing to the “speculators”.
Brian Dalley is a leading Property Consultant | former NZMBA Mortgage Broker, and Real Estate Agent.
Comments