How Could A Capital Gains Tax Affect Your Property?
There’s a lot of talk about a potential capital gains tax coming in on property. What does it mean for your family home, or your rental investments? Amanda Watt, of Shortland Chartered Accountants, explains.
12 October 2021
How did the proposal come about?
Earlier this year, the government set up the Tax Working Group to look at improving the fairness, balance and structure of our tax system for the next 10 years.
It’s released an interim report with suggested changes – including some dramatic changes to how property could be taxed.
The Tax Working Group’s interim report, released in September, looks at extending the definition of ‘income’ to include ‘capital’ income.
In theory, this is not a capital gains tax, but it merely widens the scope of what income can be taxed. But to me, whatever the working group chooses to call it, this looks like and smells like a capital gains tax.
What are the pros and cons?
The advantages of introducing this capital gains tax are to improve the fairness and integration of the tax system, levelling the playing field between different types of investments, increasing sources of revenue over time, and enhancing the sustainability of the tax system.
The disadvantages include an increase in administration and compliance costs, and a potential decrease in the overall savings and investments into the economy.
What’s the situation now?
New Zealand already has a ‘pseudo’ capital gains tax, where you pay tax on the profit from some land transactions. For example, if you buy a property intending to sell it in the future for a profit, then your gain will be taxable.
The Bright-line rule is another example. If you buy and sell property (with some exemptions) within a five-year period, then you’re taxed on your profit. This gain is now treated as income and is taxed under the income tax rules.
The Bright-line rule targets only property, not businesses, shares, or any other investments.
What’s the preferred proposal?
The preferred proposal, recommended by the working group, is what I would call a pure capital gains tax. This means any gain on your property will be considered ‘capital income’ and you’ll have to pay income tax on it.
The group is suggesting that there’ll be an effective valuation date – on a particular date, all your assets would be valued and then you’d pay tax on any gain from there on.
For example, if you originally bought a property for NZ$400,000, which is worth NZ$750,000 at the effective valuation date and you sell it several years later for NZ$1 million, then NZ$250,000 would be considered taxable income, even though your full capital gain on the property would be NZ$600,000.
Under this proposal, the group considered two options.
The first option was taxing on a ‘realisation’ basis, which means the tax is not triggered until you sell. The second option was on an ‘accrual’ basis, meaning every year (normally) you value your property and pay tax on the gain even if you haven’t sold it.
This would have a big effect on cashflow for investors. The tax working group has recommended the first option, even though one of the big disadvantages of this is the potential for ‘lock-in’. This effectively means investors would choose to hold onto property, rather than selling it and having to pay capital gains tax.
The second option
The second proposal, which is not backed by the Tax Working Group, is based on a ‘Risk-Free Rate of Return’. There are other examples of this already in our tax system, for example, the Foreign Investment Funds (FIF) regime.
Through this plan, a Risk-Free Rate of Return would be applied to your equity in a property (the part that you own).
The example rate used in the group’s interim report is 1.8 per cent. This would mean if you owned a property and your equity in it (the value less the borrowings on the property) was NZ$1 million, then NZ$18,000 (1.8 per cent of NZ$1 million) would be included as income in that tax year.
All other income and expenses would be ignored in this option. This could have a big impact on investors’ cashflow, because under the Risk-Free Rate of Return, you haven’t received that income, but you’re paying tax on it every year.
The tax working group hasn’t recommended this method, and prefers the first option.
What about the family home?
The family home looks to be safe from a capital gains tax. The government has said that the tax working group wasn’t allowed to consider a capital gains tax on the family home.
It’s unlikely that any political party would support a capital gains tax on the family home, anyway, as this strategy wouldn’t be likely to win them votes.
I believe if a capital gains tax is to come in, it should cover all assets, including the family home. My reason is the ‘mansion effect’, where people would buy more expensive homes, because the capital gains wouldn’t be taxable.
The working group has recommended putting a threshold in place so, if a family home was sold for, say, more than NZ$5 million, then the amount over this would be taxable.
What about baches and second homes?
There’s been a lot of publicity recently around baches and second homes. Under the preferred plan, these will be taxed, because only the family home will be exempt, and you’re only allowed one family home.
Under the preferred option (‘capital gains tax on realisation’), you’d only need to pay tax after the asset was sold, and then only on the increased value since the valuation date.
Based on the working group’s interim report, all capital gains so far won’t be taxed – it’s only future gains.
What happens now?
The Tax Working Group’s final report is due in February 2019. For more information, visit the Tax Working Group website.
First published 26 November 2018
Story by Amanda Watt. Amanda is a director and co-owner of Shortland Chartered Accountants Limited. She is a chartered accountant and, while dealing with a wide range of industries, specialises in property. She is on the board of both Auckland Property Investors Association (APIA) and New Zealand Property Investors Federation (NZPIF).
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