NZPIF Depreciation Submission

21 Oct 2004

The Federation established in 1983 comprises fifteen local associations throughout New Zealand, is the national body representing the interests of over 3500 property investors, owners and managers.

The Federation represents and promotes its members’ views on all matters affecting property investments and has a particularly keen interest in relevant tax issues.

The Federation welcomes this opportunity to comment on the issues paper and the concerns that it raises.

Specifically, the Federation wishes to focus its comments on chapter 9 of the paper that addresses the rules for depreciating rental housing.

In short, the Federation is opposed to any changes to the current depreciation regime on residential rental housing that has been working efficiently and well for the last ten years.

Setting the Scene

The Federation notes that the current depreciation regime has been in effect since 1 April 1993.

Its provisions became mandatory from the 1995/1996 income year.

Changes introduced in 1993 included the IRD increasing the rate of depreciation for residential investment properties.

The base rate was lifted from 2.5% straight line to 4% diminishing value. Importantly, this was clearly done after much expert study and detailed consideration.

To the Federation it seems backward looking and quite incredulous, that ten years on, the authors of the issues paper recommend reversing depreciation rates on rental housing. Such an ad-hoc approach will not engender much public confidence or support.

IRD Proposals

Whilst the Federation supports regular reviews of the various tax laws and regulations, the current review appears to be driven by short-term political ideology rather than by any serious breakdown with the current regime.

The issues paper says the present depreciation regime on rental housing properties, that currently allows an annual deduction of 4% of a building's diminishing value over 50 years, may be “too generous”.

Accordingly the issues paper advocates replacing it with a limited straight-line depreciation of 2% a year (which would be equivalent to about 3% a year on a diminishing value basis).

This means that, for example, a landlord who owns a $150,000 building will have their taxable income increased by around $15,000 over the first six years - forcing them to pay an extra $5,000-$6,000 in tax over that time, or $1,000 a year.

A second suggestion is for a list of separately depreciable assets to be drawn up, as in Australia, which would include domestic appliances, hot water cylinders, air-conditioning systems, light fittings, carpets and lifts.

It would not include wiring, plumbing and internal walls, which officials consider being part of the residential building.

This approach is illogical as two different taxpayers with otherwise identical properties, but configured as a “commercial building” e.g. serviced apartment, would be able to depreciate structural items separately and at higher rates, whilst the other taxpayer may not.

For all rental housing investors, the proposed changes are unsettling and will cause much concern as to the wider financial and downstream effects.

Moreover, the proposals are subjective and are viewed by Federation members as a direct attack on their enterprise and initiative to provide for and secure their family’s financial future.

A case for no change to the status quo

The current depreciation structure provides certainty and consistency to rental housing owners and is not a “rort” as some people like to think.

The above approach, suggested in the issues paper, appears to have been formulated to minimise or reduce so-called tax ‘incentives’ in rental housing.

Therein lies one of the pitfalls.

Under the proposed approach there would be lower rates of depreciation allowed.

This could affect the structure and profitability of rental housing investments that may be highly debt-funded and catch out those who may be financially over-extended.

Any spare resources are usually used to fund any cash shortfall in the rental property.

If an investor’s cash flow is reduced and the shortfall widens this may cause problems to a finely balanced investment. In an extreme case cash flow problems could lead to a forced, and or mortgagee sale.

A downstream effect could see rental housing owners seeking to recover the increased tax costs from higher rents.

Of course higher rents will be passed on to tenants, and thus an innocent party is unintentionally and directly penalised by an ill-considered tax change.

The situation is made worse for the Government under pressure to increase state benefits such as the accommodation supplement to offset the tax induced increase of rents.

The proposed depreciation changes could be socially disastrous in the future and runs counter to government initiatives to ease the current housing shortages.

Even if the rental housing investment is not performing well, under the proposed changes they may be placed at risk and make further debt funded rental property purchases economically unviable resulting in the curtailing of new investments.

Instead of setting depreciation tax policy and mechanisms that actively discourage rental housing investment, the Federation is of the view that depreciation and tax settings should be doing the reverse, that is be more sensitive and encouraging of housing accommodation investment.

Rental housing is a business

Depreciation is an allowance that takes into account the fact that income-producing assets and chattels show wear and tear and lose value over time.

This applies to most assets in any business.

Therefore, as a business, rental housing investors are entitled to claim fair depreciation on the building and its chattels that have different 'estimated useful lives”.

The claiming of depreciation for most rental housing owners largely relates to the timing of tax payments.

Depreciation Recovery

Rental housing owners are aware that, even if a property is held long-term, when it is resold depreciation is clawed-back and payable to the Government.

This is fair and reasonable.

However, what is not fair and reasonable is the potential for mid-stream changing of the rules and any new obligations on investors.

The claw back process (as well as other tax measures) acts as a natural brake on speculative investors who might be contemplating the sale of a property because they’ve made a gain (or expect to).

The risk of paying more tax to the Government is an important inhibitor of people taking advantage of, or abusing, the current depreciation allowances.

Taken together, investors might be more reluctant to sell and trigger depreciation claw back thus creating or exacerbating another problem of artificially constraining market supply such that it forces up property prices – thus again affecting affordability.

Changing market trends

The argument advanced by some, including economists and bank commentators, that rental housing is attractive because of certain tax considerations (even though the ‘considerations’ are the same for any income producing business), is over-emphasized.

The so-called ‘good times’ (the last 18 months or so) for rental housing ownership has now passed. The attraction of rental housing as an investment is now not so great, is evidenced by a progressive slowing down in the market.

If changes to the depreciation regime are meant to cool or dissuade the market then there is little need for the Government to interfere.

A combination of the following market influences, currently in various states of play, all serve as a natural corrector of the market:

• Falling immigration numbers
• Static population growth
• Ex-pat kiwis (returning home following 9/11) now leaving NZ
• Declining annual rental yields (of between 3-4% down from 7-11%)
• Increasing supply of new private houses and state houses (according to HNZC an extra 4,200 homes since 1999)
• Rising interest rates
• Sustained low inflation
• Better performing managed funds and international and local equities

Inconsistent with other government policy

The issues paper suggested approach to depreciation is too simplistic. It potentially conflicts with other government policy initiatives or goals, especially where they relate to the provision of housing and accommodation.

The new depreciation proposals, whilst they could net the Government an extra $30 to $40million a year in tax, will be costly for all rental housing owners (estimated to be over 164,000 individual taxpayers), all tenants and other relevant State agencies.

It is ironic that the Government is actively courting private investment in housing through its long term partnerships and leasing program, offered through HNZC, but its revenue gathering arm ignores the wider social housing goals, including more houses and stable tenancies by sabotaging any benefits by recommending knee-jerk depreciation rule changes.

The depreciation proposals flagrantly overlook the importance of the private rental sector to the wider national economy and as a leading provider of accommodation and housing solutions for an increasing number of New Zealanders.

To illustrate the point, Census information shows 32.2% of the population rent their home rather than own it. This is up from 26.2% in 1991.

The Federation believes that it would be Government’s preference to see the private rental sector, an important component of the economy and social fabric, thriving rather than hamstrung and struggling.

Private rental housing owners are the most flexible and cost effective means of providing housing stock and accommodation to New Zealanders.

Other Concerns

The Federation is extremely concerned that the issues paper gives no warning as to when the proposals might be implemented and brought into effect, whilst elsewhere it has been well signalled that changes will be in time for legislation by the end of the year.

Moreover, the Federation would be strongly opposed to any suggestion that the proposed changes be retrospective. As well as being administratively fraught it could also mean more financial pain for rental housing owners possibly caught out with use of money interest and late payment penalties. This would be totally unfair The Federation would urge that should changes be forced through, that they be sensibly implemented in a forthcoming income tax year, perhaps commencing 2006/2007. Such a future implementation date would allow investors to be better able to work within the new regime.

It would also be fairer to investors who have been operating in good faith, following the IRD guidelines to avoid problems.

Summary

The Federation is strongly opposed to the proposals contained in the officials’ issues paper advocating a tougher depreciation regime.

Small-time mum and dad rental housing owners do not need to be punitively attacked for a relatively small revenue advantage.

Government intervention to regulate the housing market by way of manipulation of depreciation rates is not needed as there are other and more effective self-correcting mechanisms at work.

Poorly thought through tax policy does not lead to greater prosperity for all and has a strong potential to backfire on the Government and exacerbate problems in wider social policy areas.

The Federation urges that the current depreciation regime, which has been working efficiently and well for over 10 years, not be tinkered with. Current depreciation settings should be left unchanged. However, clarifying editorial notes to the “Rental Income booklet” could be helpful.

Craig Paddon

President NZPIF