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Guide To Taxation Of Rental Properties

Contributor:
Mary Holm
Mary Holm

Reader feedback keeps coming about the taxation of rental properties. So I've decided to go to the horse's mouth, Inland Revenue. But first, a typical email on the subject:

"My colleagues who own rental properties and sold them for a profit swore that they do not have to pay capital gain tax, nor do they need to repay any rebates on their income taxes claimed on losses made on their properties.

"Apparently their accountants were able to do some tricks by using the loss attributing qualifying company setup (I gathered). Another said that he just did not report the sale of the property. It seems that the IRD is quite lax on this matter."

There are two issues here:

What should happen, according to the law

New Zealand has no capital gains tax as such. However, traders have to pay income tax on their gains, and so does anyone else who goes into an investment "with a purpose or intention or resale" - as opposed to, say, buying a rental property to hold indefinitely, to receive rent from it.

Your purpose at the start is the deciding factor, no matter how long you own the property.

What about loss deductions? The clawback when you sell is not about losses, it's about depreciation - although depreciation certainly contributes to losses.

When you sell a rental property, take the lower of the sale price or the original cost. If the depreciated value is less than that - which will usually be the case - you must add the difference to your taxable income.

This also applies if you switch from business to private use of the property, perhaps by moving into the rental yourself, or if a trustee distributes a property to a beneficiary. In these cases, use market value instead of sale price.

The clawback is fair enough. You have claimed depreciation that hasn't actually happened.

For more detail, see Inland Revenue's publication, "Rental Income - IR 264", which you can download from www.ird.govt.nz.

What does happen

No doubt some people get away with not paying the tax they should.

However, Inland Revenue's national manager of technical standards, Graham Tubb, says the department puts "a lot of effort" into investigating property gains. In a recent year, they looked at 6,000 cases of possible property speculation.

If someone is negatively geared for most of the time they own a rental property, Tubb says that would increase the likelihood that Inland Revenue would consider they had bought for the purpose of resale. But the department would also look at other factors. "Negative gearing on its own doesn't prove what their initial purpose was. "

So how is purpose proven? If you are audited, Inland Revenue might look at statements you made to a bank manager or accountant when you bought, or any plans you may have made.

"In a dispute," Tubb says, "the onus is on the taxpayer to convince the court that he or she didn't have the purpose of resale."

If you can't prove that - or if you didn't pay the depreciation clawback - you might end up paying not only the tax owing but an extra penalty, as well as interest. And interest can add up fast if the transgression was years ago. Our emailer's colleagues might be playing with fire.

A final point: Tubb is puzzled by the reference to loss attributing qualifying companies (LAQCs). Having such a company wouldn't prevent your having to pay tax on capital gains or depreciation clawback if the company sold the property, he says.

Mary Holm is the author of bestselling books on KiwiSaver and personal finance. She is also a highly praised seminar presenter.
Her written advice is of a general nature, and she is not responsible
for any loss that any reader may suffer from following that advice. 

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