Posts Tagged ‘depreciation changes’

I am back from a cameo visit to Sydney today where I was a paid presenter for a six hour module on “Investing in New Zealand”.  I was very interested to see the announcement from the Government that LAQCs which I knew were going to be abolished but thought they had left the door open for some offsetting of losses against personal income.

The writing has been on the wall for a long time for property investors using Loss Attributing Qualifying Companies (“LAQCs”).  We know that the ultimate goal is to ring fence tax losses completely, so we property investors cannot use the LAQC ownership structure (our vehicle of choice) to offset rental property losses against or salary/wages.  Investors should not be surprised about this, although the hopes of many appear to have finally been dashed with the hope that there would still be the ability to deduct tax losses against income from personal exertion to the extent of capital contributed or even more hopefully against the amount of loans personally guaranteed.  Now the missing piece of the puzzle has been found – with the Minister of Revenue, the Honourable Peter Dunne saying this afternoon that “the Government would introduce new rules preventing loss attributing qualifying companies (LAQCs) from passing losses on to their shareholders.”

How did LAQCs become such a problem?

Lets look at this issue.  I don’t use LAQCs myself, instead preferring the asset protection (creditor protection, succession planning) benefits that well managed trusts bring along, with some incidental tax benefits, since I am not ‘normal’ and like to buy properties that make me money.  A lot of investors have bought on the rising market during the boom from 2003 – 2007 and fair few bought in 2008 thinking the market was just taking a short breathe before it would go up in value again.

The credit criteria for getting bank loans were very relaxed from 2004 until the Global Financial Crisis kicked into gear in New Zealand around September 2008.  Investor friends of mine were able to get their effective tax rates down from over 33% to below 15% through rental property losses being attributed via the LAQC against their salaries.  Instead of being net taxpayers, property investors (particularly residential property investors) became net taxrefundees! In 2003 before the last property boom kicked off there were $710 million of losses from LAQCs.  This more than tripled to a significant $2.256 billion by 2008.

The Tax Working Group made a big thing of this in 2009, and the information they had from Inland Revenue and Treasury showed the last two years that property investors were making big losses, despite control what they perceive to be well over $150 billion worth of property.

As a result of the financial crisis affecting companies, reducing consumption spending, rising unemployment and lets not forget the fact that we have many hundreds of thousands of New Zealanders not earning a single cent who have been in increasing numbers totally dependent on Government handouts, our Government has been suffering reduced income, yet facing increased expenditure pressures.  We are losing money to the tune of over $200 million per week.  This has to be borrowed at interest from abroad.  A few things had to give in the May 2010 Government budget.   One was the consumption tax that is Goods and Services Tax (“GST”) being raised to 15% with effect from 1 October 2011, another was building fit-out items being deemed to be fixtures and classified as part of the “building structure” eg. tiles and vinyl flooring is now depreciated at the building structure depreciation rate, and the building structure depreciation rate has been reduced to 0% (from 3% diminishing value, 2% straight line) with effect from 1 April 2011.  At that time the Minister of Revenue the Honourable Peter Dunne and the Honourable Bill English as Minister of Finance suggested that there would be tax changes to LAQCs.  We knew changes were coming – we had thought that LAQCs would be taxed as Limited Liability Partnerships and have to file IR7 returns, with LAQCs would be abolished to just be qualifying companies.  Now far more light has been shed with LAQCs and QCs being able to continue, just without the ability to attribute losses to their shareholders! So from 1 April 2011 LAQCs will lose their major benefit – being able to reduce their taxable income.  They called for submissions on this and wanted to work out the detail.  My previous blog contains the Press Release.

My Interpretation

If you have an LAQC you will need to take an extremely serious look at your structure and indeed portfolio and look for options on what to do with it.  The draft legislation will give full certainty, but one thing is for certain.  If you have an LAQC and make tax losses from which you have been offsetting your personal income – you will not be able to do this post 1 April 2011.  You will need to make changes, and before 31 March next year.

Follow the text of the draft legislation very carefully and look very carefully at your depreciation claims.  As Steve Tucker the owner of NZ’s leading chattels appraisal company Valu-it said in his address to APIA in July 2010, that depreciation claims are likely to be slashed by 60 – 85% depending on the type and nature of the property.  Older buildings with few valuable depreciable fit-out and chattels items would be amongst the hardest hit, as would commercial property as their is very little Landlord fitout or chattels.

Look at your latest set of financial accounts and analyse what is likely to happen to you post 1 April 2011.  If you need to make changes I would strongly suggest that you talk to me and we can look together at all of the fantastic benefits that trusts can provide you with.  Having worked at both leading chartered accountancy firm Deloitte, leading law firm Russell McVeagh, being a successful property investor myself, and having worked with property investors on ownership structures for a number of years, I can work with you to balance tax optimisation and asset protection objectives in this challenging political climate.  Contact me at david@davidwhitburn.com or on direct dial (+64 9) 528 5533.

Quotable Value, the Government Valuation agency released statistics today showing that we are still in the downturn phase of this current property cycle.  Property values have declined by 1.1% since 31 March of this year.  Values however are 3.1% above where they were on 31 August 2009, but this is 5.0% down from the peak of the last boom in 2007.

Lets take a look at the past 5 years to process the QV statistics graphically:

You can see the market growing relatively rapidly (and not just because the left hand axis starts at 70% and not 0%) from August 2005 to August 2007 and then reaching a plateau like Table Mountain in the Coromandel Ranges that I used to like tramping in.  Then in April 2008 to April 2009 the market retrenched nearly 10% from the peak.

I Love Auckland – New Zealand’s Super City

I feel it is important to focus on Auckland as I am an immensely proud born and bred Aucklander, and the fact that Auckland is our nations economic hub and New Zealand’s biggest city by far. Interestingly Mayor of Auckland City, and leading Super City (Auckland region) Mayoral Candidate John Banks said in his address to the Auckland Property Investors’ Association (APIA) last month that people are looking at migration decisions (both immigration – coming into Auckland or emigration – leaving it) as being an issue between cities and not countries.  Therefore it is important to know where we our leading city stands.  Mercer, an international recruitment and consultancy firm, publishes an annual survey of all the leading cities in the world.  In the 2010 Mercer Quality of Living Survey Auckland defended its 4th position (equal with Vancouver in Canada).  Wellington deserves an honourable mention at 12th this year too.

The statistics for the Auckland region show a fairly similar story to the rest of the country which is unsurprising since Auckland property sales make up over a third of the index, so it is most heavily weighted in Auckland’s favour. However the statistics do show that Auckland suffered a slightly deeper decline than the rest of the country in 2008 and into mid 2009 before an encouraging recovery to be at 31 August 2010, only 2.4% down from its late 2007 peak:

Is it right to lump all of Auckland together?

From a personal perspective the statistics need a little bit of fair review and criticism here, as it is perhaps unfair to lump a city of over 1.4 million people together as one market.  We could be more relevant and break Auckland down into the CBD to include our apartment market, into East Auckland, which is so different from South Auckland, yet united by being part of Manukau City, West Auckland, Central Auckland (again so large that this should be split up as the more affluent areas are so different from the middle of the road areas), the North Shore, Papakura etc.  I wish QV would break down the statistics in this fashion – after all these sub markets are far bigger than small cities like Dunedin and Hamilton, and both Auckland City and Manukau City (South & East Auckland) are bigger than both Wellington and Christchurch. Since I don’t have this data for these sub areas, or separate housing markets of Auckland, I will have to give you my own take on things.

Interestingly last year some self proclaimed Property Gurus and real estate agents mistook the mid to mid-late 2009 price increases as being a sign that we are in the boom.  They got it wrong.  This in actual fact was only a slight recovery after a severe decline in 2008 and early 2009 – the statistics from QV above clearly show this.  My mentor in 2003, Kieran Trass of the Hybrid Group, showed me that in each of the previous four property cycles that the slump (or what I like to call downturn) phase of the property cycle lasted longer than the boom immediately preceeding it.  APIA’s principal sponsor ANZ, had Craig Moffat stating at the NZPIF Conference in 2009 the very same thing. I currently believe that we will be in the downturn phase for at least another 2 years, before the recovery begins.

I want to share with you my story which comes from helping my younger sister purchase her first house. I have been to many centrally located auctions in Auckland over the past 12 months or so with Barfoot and Thompson’s Wednesday afternoon ‘mega’ auctions at their lovely Chancery Court building in the CBD, and onsite in homes in Epsom, Mt Eden, Ellerslie, Remuera, Parnell, Kingsland, Ponsonby, Westmere, and Grey Lynn.  There were many people going to auctions and some crazy prices bid, particularly towards the end of last year and early this year.  However now in these centrally located affluent suburbs of Auckland there seem to be fewer buyers than before and in general the bidding isn’t silly, but the prices achieved are often pretty good.  This is an interesting “market depth” issue as the volume of sales is very low (see graphs from Realestate.co.nz Limited below for 1. New Property Listings which are well down,  and 2. Inventory – the number of weeks to sell all of the listed property.  Note that Auckland has a 36 week inventory as a region, so we are not as bad as the 46 weeks graphed which is the NZ overall inventory):

The reported sales for July from REINZ were 4,411 which was the lowest July on record, down 27% from July 2009.

So from around April 2009 onwards the Auckland prices had a slight recovery but there is downward pressure again without much wage inflation, with a necessary change in mindset to reduce debt and to get away from the I want it now mentality and going back to needs and not wants.  Also investors are shortly going to feel a bit of a pinch with depreciation changes and paying 2.5% more on rates, insurance, property management fees and repairs & maintenance costs.  That is counterbalanced somewhat by receiving some personal tax cuts, but the positive impact of tax cuts combined with the negative impact of depreciation expenses being decimated plus GST rises mainly provide a net benefit to investors with small portfolios (1 – 2 rental properties).   There will be a spin-off for houses in medium and higher value areas as they will have a vast number of people earning over $70,000 per year and having their personal tax rate slashed from a very high 38% to 33%.  More money will be spend on improving housing, new kitchens that were held out for the past two years, upgrading that cracked driveway, improving the gardens, and some more consumable spending like getting that new 55in LED TV will happen as well.  My sister is still looking for a home with her fiancee in central Auckland near her CBD office.

Increase Your Rents

I got called earlier this afternoon by the New Zealand Property Investor Magazine to talk about rents in Auckland.  I talked about splitting Auckland up into sub markets as above, and noted the performance in particular of the North Shore which has had strong rental demand in general.  The pressures to increase rents are present, but are stronger in the more affluent areas – the tax cuts tenants will be receiving, plus landlords facing increased expenditure from GST rises, the ill fated Emissions Trading Scheme and the slashing of our depreciation expenditure mean tenants acknowledge that they will be facing rent increases.  Since like the rest of New Zealand the Auckland Property Market is still in a downturn, waves of capital growth aren’t coming anytime soon as we have yet to even reach the recovery phase of the property cycle.  So lets not let our tenants down!  Give them the rent increases they expect.

Acknowledgements: www.realestate.co.nz and www.qv.co.nz for their excellent statistical collection and compilation

PRESIDENT’S REPORT FEBRUARY 2010

Happy New Year and Decade everyone. We trust your are all enjoying another beautiful Auckland summer and are back into the groove. The Auckland Property Investors’ Association (APIA) has a great line-up of speakers for you again this year, and we are planning a special seminar for May this year too, that will be highly topical and popular. We had a large February Keynote meeting and an outstanding presentation with Dean Edgerton, Director of Markets from ANZ National Bank Limited. Dean heads the dealing room of New Zealand’s largest financial institution and was able to shed light on interest rates and their likely direction, and cover why long-term interests are so much higher than floating and shorter term fixed rates.

Market Review

It felt like 2009 went quite quickly, and it certainly was an interesting year for property investors. For Auckland properties we saw rents increase healthily in 2009, particularly in the mid-high socio-economic areas, yet some areas were hit hard by unemployment and towards the end of 2009 a tougher approach by Work and Income New Zealand. Our property values, recovered nicely from the doldrums of 2008. Whilst history provides no guarantee of the future, it can show trends and give strong indication of future direction. So lets take a look back at the decade to see what happened to house prices. In December 1999 the median sale price in Auckland was $235,000, and we closed out the ‘noughties’ decade in December 2009 with our city’s median sale price being $476,500. This represents a 103% increase in capital growth, or an average annual capital growth rate of 7% across the region as a whole. Over the decade the values of residential properties (this excludes residential sections and commercial properties) traded in the Auckland region (through real estate agents) was a massive $125 billion dollars.

So you can see property was a great investment over the decade, and the Auckland Property Investors’ Association was proud to assist you in your decision to take responsibility to become financially free, and to help make decisions that will assist you plan your own retirement – and in many cases we hope an early one! We look forward to servicing your needs and providing a platform for networking with you for another decade.

Tax – The Topical Issue

Normally tax is perceived to be pretty dry and boring, and an area reserved for mega geeks in grey suits with white shirts and black suitcases with packed lunch where they toddle off to work each day, come home, read some legislation, case law or tax information bulletins and then they go back to work in their grey suit, white shirt with their packed lunch and repeat this every day. I know as I used to be a full time tax lawyer working at Big 4 Chartered Accountancy firm Deloitte and then at leading law firm Russell McVeagh, before I saw light of becoming a property investor and immersing myself into the market. However times have changed and tax is cool once again. I can say to my many friends who are tax lawyers and accountants, that tax is very interesting, and highly topical. For many APIA members 2008 and 2009 were tough years. Some members have sadly even hit the wall being smashed in a high tide of debt as the property price wave crashed down upon them. Other members with lower gearing and sound management systems however thrived and been able to put their rents up and found respite with interest rates coming down from cyclical highs and property values recovering last year.

There was keen interest in the property market this summer, but this changes when the Tax Working Group published its findings on 20 January 2010. The relevant recommendations to property investors are:

1) Raising GST to 15% or 17.5%
2) Imposing a Capital Gains Tax on all properties, or excluding owner-occupied housing
3) Imposing a Land Tax at 0.5% of the property’s land value
4) Imposing a Tax on the net equity investors have on their properties (assuming a 6% return on equity invested, and investors would ignore rental income and all expenses, as only the equity invested is relevant) – thanks sharemarket CEOs/fund managers with vested interests recommending this market killer.
5) Removing depreication on buildings
6) Removing loading on new assets
7) Bringing the top personal tax rates down, to be the same as the company and trust tax rates (ideally all at 30%, with perhaps the company tax rate being even lower depending on what Australia do)

These recommendations were praised by the usual suspects that despise residential property investment including the Gareth Morgan (Fund Manager of Gareth Morgan Kiwisaver & Economist), Mark Weldon (NZX CEO & chief cheerleader of NZ’s long suffering sharemarket), Bernard Hickey (interest.co.nz) and the Green Party.

However we had mostly good news last week with Prime Minister John Key’s opening address to NZ Parliament stating:

we will not be developing any proposals for a land tax, a comprehensive capital gains tax, or a risk-free return method (RFRM) for taxing residential investment properties,”

So it appears that there will no land tax, no CGT or that ridiculous and market annihilating risk-free return method imposed on us. However Key said that the Government will “be making changes to the way property is taxed, which will result in increased Government revenue and more fairness for the taxpayers. These changes will be announced in the budget.”

What this means for investors:

It is reasonably good news now with no Capital Gains Tax, Land Tax or Risk-Free Return Method being applied. But still the Government thinks “there is a gap in the current tax system around property investments where income is being derived but, in aggregate, no tax is being paid – in fact the government is actually losing revenue in this sector.”

We would vehemently argue against this as only in 2 of the past 28 years did the Government make a net loss on residential property investment. The 2008 income year was used by the Tax Working Group and that year had cyclically high interest rates (floating rates all above 10%, most fixed rates exceeding 9%) and peak prices in the cycle. Unfortunately the Government do not seem to understand this and are not listening to us. It seems that our depreciation claims will be slashed. It is likely that there will be a 0% rate of depreciation for building structure (residential and commercial), just like land! This is a little absurd. We have members with leaky buildings in their portfolio – try telling them that their property has not depreciated! It is likely that the 20% loading for new assets will not be there either. So we need to wait until May’s budget to find out exactly what is happening. I think members should wait and make an informed decision and not make a hasty decision that is later to be regretted to sell their property.

If you are not impressed about these changes, remember the politicians are their to serve us, and they need our votes next year. So consider lobbying to protect your rights. Do what some other members and I are doing and contacting your local MP. Otherwise email your own personal letter to Prime Minister John Key, Finance Minister Bill English or Revenue Minister Peter Dunne.

David Whitburn LL.B BSc
Vice President
Auckland Property Investors’ Association (Incorporated)