Friday, 25 November 2011

Capital Gains Tax on New Zealand Property?

rebloggered (new word ian ? ha ha ) from :

Capital Gains Tax on New Zealand Property?

Well there has certainly been a heap of debate over this week’s ‘leaked’ Labour Party proposed introduction of a Capital Gains Tax (CGT) on Investment Property in New Zealand (if they should happen to be successful in the upcoming election later this year)

I personally feel that the Labour Party has just committed Political Suicide, and they will not be elected into power, but you just never know, crazier things have happened.

The fact that it has now announced that the same proposed 15% Capital Gains Tax will also be applicable to the sale of Farms, Businesses and Shares on the Stock market, do further cement my thoughts that they don’t have a hope of getting into power this time around.

One thing I do know for a fact is that New Zealand is one of the few developed countries in the World that doesn’t have a Capital Gains Tax on Property. And that if it is not introduced this time around, it is inevitable that NZ will get a CGT at some stage in the future.

Whilst I am obviously against the introduction of a Capital Gains Tax on property, if and when a CGT is introduced its certainly not the end of the World for Property Investment in New Zealand, especially for ‘Buy and Hold’ investors like us that don’t make a habit of selling property anyway. But instead keep buying to build up a large asset base for the income that those properties generate, and the ongoing growth in asset value over time.

What part of that strategy involves selling a property?
Therefore no ‘realised’ Capital Gain to pay CGT on.

People that do buy property with the intention of selling to make a profit (Property Traders) in New Zealand do already pay income tax on their profits (Capital gains) currently anyway. Just the same as any business does when they buy an item, then sell it for a higher price and pay income tax on their profits, so paying tax on a capital gain is nothing new for the Property Traders.

As I mentioned above, many other developed Countries have had a CGT on property for quite some time, even our closest of neighbors Australia. A CGT was first introduced in Australia in 1983. Any capital gain made from selling an Investment property is added into your gross income for that year, and then taxed as income at your own personal tax rate, so the rate of CGT on property in Australia is on average far greater than the 15% that the Labour Party is proposing here in New Zealand.

Australia also has another form of tax on property purchases, that being Stamp duty. On the purchase of a property with a value of $300,000 Stamp Duty will add a minimum of $9,000 extra to the overall purchase costs (higher in some States). With a property worth around $500,000 Stamp duty amounts to anywhere between $16,000 (Queensland) and $25,660 (Victoria) which is a sizeable tax, and it’s payable upon purchase, so there is no avoiding it, buy never selling.

My point is that Investment in Property in Australia is still today an extremely feasible and very financially rewarding form of investment, and they have had CGT since 1983 as well as the extra tax, Stamp Duty, which we don’t have here in New Zealand.

Ok, so if I don’t ever sell any property how do I get access to the cash?

So if your plan is to keeping buying property, and build up a large asset base, and you never sell, how do you access cash from your property portfolio?

When you initially purchase each property, it may only just be self funding, or have slight positive cash flow. And you might be thinking that you won’t be able to buy enough property to replace your income and live solely off your property portfolio?

But what you must remember is that as the years go by rents are increasing, and 5-10 years down the track the positive cash flow generated by each property is generally far greater than it was when first purchased. Once you have purchased enough income producing property, and rents increase over time, it is quite possible to live off the surplus rental income generated.

There is also another way….

Once you have built up a large enough asset base, you are able to live off the increasing equity of your properties. This is a very effective way of funding your lifestyle or retirement from the increasing value of your property portfolio.

To simplify this strategy, as your property portfolio continues to increase in value over time, you borrow against your increased equity, and use this borrowing to fund your lifestyle or retirement.

So let’s look at this a little further, 10-15 years after you start investing, and you have built up a property portfolio that is worth say $5,000,000. Because you have bought every property below value and have also had some capital gain over that period, you are only geared to 50% of the total value, so you have mortgage debt of $2,500,000.

Say you were still working at your day job, and you were earning a gross income of $100,000p.a, after paying PAYE income tax you will be left with $76,000.

If instead of working, you were to approach your lender, and ask to borrow $100,000 against the equity in your property portfolio they would set up a Line of credit for you, on which you would pay interest on any amount drawn down at the current floating interest rate, for example sake, let’s assume 7%. So after allocating the first $7,000 towards paying interest, this leaves you with $93,000 to live off for the next 12 months (or longer).

Here’s the interesting bit, this money is not income, so you don’t pay any income tax on it. It’s not a capital gain from selling a property, so you don’t pay any capital gains tax on it (assuming we have a Capital Gains tax)

You might be thinking, yeah that’s great but what happens after the first year, you’ve spent all your borrowed money, and you now have an extra $100k of debt, and how are you going to live for the next year? Well, you have to borrow more. Many of you might be thinking that this doesn’t sound very smart? But if the value of your assets are appreciating by far more than you are borrowing against them, and your rental income is increasing as well, to be able to service the increased mortgage interest, it is quite a sustainable strategy.

This ‘Living off equity’ strategy is certainly not for beginners, it’s a fairly advanced strategy that should only be applied once you have already built up a sizable asset base, with substantial net equity, normally at least $1.5-$2m minimum.

The reason I have mentioned it here is merely to show that there are certainly alternatives to actually selling down the Assets, to be able to benefit from and live off the growing equity base. There is obviously a little more to it than what I have mentioned here, but this gives you the general idea. We cover this ‘living off equity strategy’ in greater detail in the final module in our e-Coaching Property mentoring program.

So I as I mentioned at the beginning of this article, while I am opposed to the introduction of any form of Capital Gains tax in New Zealand (for obvious reasons), it would be na├»ve for any of us to think that it isn’t going to happen eventually.

And that if and when a Capital Gains tax is applied to the sale of Investment Property in New Zealand, it doesn’t have to negatively affect our investing as much as you may have first thought it would.

As per normal the media love to get hold of stories like this and they have an absolute field day, putting the fear of God into the general public. But as you can hopefully see by now, it’s certainly not as bad as some might think it would be, and by no means is the introduction of CGT a deal breaker for me and my property investing.

Regards, and successful investing,

Clint Taylor

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