Capital gains again

Capital gains tax is back in the news. Another article telling us how it will save the world. This from?a newspaperQuote:

Introducing a 10 per cent capital gains tax would reduce New Zealand house prices by 10.9 per cent and lead to a higher rate of home ownership, according to a leading bank economist. End quote.

No, it wouldn’t. Capital gains tax will only apply to properties owned for investment purposes. The proposed tax specifically excludes owner-occupiers. As there are far more owner-occupied houses than investment properties, the effect of a capital gains tax on house prices will be negligible. Quote:

Property prices in New Zealand are “profoundly affected” by the tax system, [Dominick] Stephens said.

“It follows that changing the tax system would change property prices.”

In New Zealand, property is more lightly taxed than other forms of investment, he said. End quote.

There are more expenses associated with owning an investment property than term deposits or shares. But if, for example, a share investor borrowed money to buy shares, the interest on the loan would be tax deductible. Quote:

Treasury and the IRD estimate that property investors pay 29.4 per cent of their after-inflation returns in tax, whereas bank depositors and owners of dividend-paying shares pay 55.7 per cent.

This is mainly because income from investments is taxed, whereas capital gains are tax free, Stephens said. End quote.

He seems to forget that shares increase in value too. If a capital gains tax is introduced, it will presumably apply to an increase in the value of shares as well. Quote:

Bank deposits yield only income, and are therefore taxed heavily. By contrast, property investments return little in the way of taxable net income and more in the way of capital gain, which is tax free. The “kicker” is the fact that expenses, including mortgage interest, are tax deductible, he said.

“This feature of the tax system is especially useful for property investors, who find it easier to borrow against their investments than other businesses,” Stephens said. End quote.

Absolute rubbish. Businesses borrow money all the time, and claim a deduction for interest on their loans. As I said before, if an investor borrows money to buy shares, the interest on the loan is tax deductible. The real issue here is that journalists never view property investment as a business. However the tax rules, by and large, treat landlords in the same way as any other business. This is something that is constantly and conveniently forgotten. Quote:

“Landlords’ debt loadings can be so high that their expenses outweigh their rental income, meaning they can declare zero or negative taxable income. Meanwhile, they can collect tax-free capital gains,” Stephens said.

“Naturally, this has made property investment incredibly popular. And that popularity has been one factor pushing house prices higher. The tax advantages of property investment have been factored into the price of property.” End quote.

It may well be that untaxed capital gains have caused property prices to increase in the past, but that particular boat has sailed. Now there is no evidence to suggest that a capital gains tax, to be introduced in 2020, will have any effect on house prices at all, certainly not in the short term. Quote:

Another quirk of New Zealand’s tax system is that property investors enjoy more favourable tax treatment than heavily indebted owner-occupiers/first-home buyers.

Property investors enjoy tax deductions for mortgage interest and property maintenance, whereas owner-occupiers do not.

“This boosts the amount property investors are willing to pay for property,” he said. End quote.

Oh, for crying out loud! The expenses on a Holden HSV are deductible if it is owned by a business and not deductible if owned privately. If this is an argument in favour of capital gains tax, they are scraping the barrel big time. Do these people not understand the difference between a privately owned asset and a business owned one? Quote:

The tax working group is considering the possibility of a capital gains tax that would exempt the family home, but would apply to other properties including rentals.

This extra expense would decrease the amount an investor could pay for a property while still realising a profit. With fewer landlords, rents would rise. And with investors willing to pay less for a property, more auctions/tenders would be won by aspiring first-home buyers and the rate of home ownership would rise. End quote.

He’s confused again. Capital gains tax will only be paid when an asset is sold. So, the tax will not be a factor in the purchase price. This is idiocy. Total and complete idiocy.

These days, most landlords are professional landlords. If a capital gains tax is introduced, it will simply be factored into the equation of managing the property portfolio. If, as the article admits, it causes rents to increase, then that alone might make property investment more attractive. There are a lot of factors for landlords to consider when buying a property but paying a possible 10% of the value of the capital gain on the property sale is unlikely to be one of them. For most property investors, so long as the position is clear, the tax will not be a major issue.

The article implies that property investors make their decisions solely to make tax free capital gains. The first reason for making any investment is to make a return. With rising rents, rental returns are very good these days, particularly in the main centres. And don’t forget. A capital gains tax introduced in 2020 will only be applied to capital gains made after that date. Any unrealised gains already made by that point will still be tax-free. It means that a capital gains tax will have little or no effect on the property market for years. In the meantime, it may scare share investors away from the markets, as they tend to spook easily anyway.

So the object of the exercise, being to encourage people to invest in assets other than property, may, in fact, have exactly the opposite effect. Now, there’s a surprise.