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Do I Need To Pay Tax On The Capital Gain From An Investment Property?

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Contributor:
Mary Holm
Mary Holm

Question:

I am a tax agent and I have offered advice to clients on the attitude of the IRD to capital gains made by individuals on the sale of rental properties. There are no clear guidelines, so I advise that should they sell, they must satisfy the IRD that they sold for reasons other than capital gain. In fact, all aspects of a tax return must satisfy the IRD, and an explanation must be available for any question that may be asked.

Regarding rental sales, the IRD do not appear to follow guidelines anyway and probably leave it to staff to decide.

I once had a husband and wife in the rental property business. The wife was a nitpicker, wanting to claim biscuits, part of the kitchen, part of the toilet, etc, as home office because an office has these things. Being recent immigrants didn't help, as I viewed them as milkers of the system.

They sold a property after about eight months' ownership for a reasonable gain. Generally I let it go, but this time I decided to ask the IRD how to treat the capital gain, as I was not a fan of this couple.

The IRD woman I spoke to looked for a reason not to apply the capital gain and eventually suggested the reason they sold was that "they did not regard the property as a suitable rental, and that is how it would be treated".

What if they had sold a second property? Would it be the same, or do two sales equal a business? Who knows? Useless guideline - why have a rule if not applied?

The couple are no longer on my list, having maybe found an accountant more compliant and less open to suggestion.

The IRD readily jump on, say, a new company being established which has a residual income tax exceeding $2500 in it's first year, laying on penalties and interest backdated to the first payment date. This is easy - like speed cameras. But when there is no hard and fast rule, the IRD takes the easy option.

Those clients I have with rentals are happy to pay only the interest on mortgages to maximise losses and tax savings. Even though the property is a millstone around their necks, the invariable response is that they will recover these losses and more when they sell.

They bought to make a non-taxable profit, period. And although times are tougher now, provided they did it intelligently, they will succeed. And as things stand, who can blame them?

Answer:

Mary Holm: This all sounds back to front and inside out. We have a tax agent arguing that their client should be taxed, and Inland Revenue deciding not to. But perhaps that's no stranger than the law itself in this confusing area.

An Inland Revenue spokeswoman responded to your comments by saying, "Staff are required to follow relevant legislation and supporting policy in all instances. What can be more challenging is how this is applied to an individual's circumstances, particularly where there may be subtle but important variables that must be taken into account."

She went on to say, "When deciding whether or not you should pay tax on the profit from the sale of a property, we look at your intention when you bought it. If you bought the property with the firm intention of selling it when prices rise, that is, to make a gain from the increase in the property's value, then the profit is likely to be taxable."

As you say, that's exactly why all your landlord clients bought their properties, but often they don't end up taxed.

Is that because, as you suggest, Inland Revenue takes the easy option? Not always, according to the spokeswoman. Over the past five years, she says, "an average of $127 million a year in additional tax has been assessed from property-related Inland Revenue investigations, and the Inland Revenue has taken a well-publicised approach to educate and promote compliance by taxpayers involved in property."

This includes the publishing, in late 2007, of booklet IR313 titled "Buying and selling residential property". You can download it from www.ird.govt.nz by doing a search on "residential property". "The booklet provides a number of case studies to help people compare their situation with the examples given and help them decide if they need to consider a tax position from the buying and selling of property," says the spokeswoman.

She adds that there's further information on tax and property transactions at www.ird.govt.nz/toii/property.

So - we have rather different stories from you and the department. Which is right? It's impossible to judge. While it's hardly fashionable to feel sorry for Inland Revenue, I don't envy its task of enforcing a law that hangs on people's intentions when they make purchases.

The Victoria University tax working group is considering whether to recommend changes to the law on how capital gains are taxed. I hope that whatever they come up with - whether or not it's tougher than the status quo - will at least let landlords and Inland Revenue officials know where they stand. And then, of course, we've got to get the Government to turn the recommendations into law.

 

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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