Making loss and being taxed is a risk, when not knowing the taxation rules. Know how to spend on home improvements, maintenance or repairs and claim rent-deductible expenses.
Taxation Rules for Landlords
Being taxed when making loss
Making loss and being taxed, yes—possible
Taxation rules level the playing ground, right? But always right is wrong! I came across a number of “funny” taxation rules. One of them is being taxed on “intention” in NZ. That rule divides business people such as property developers and traders from people who just run a landlord business or those who simply invest in properties for cumulating wealth for an early retirement.
The tricky part is—what happens when the tax department disputes your “intention” or the initial intention registered years ago has changed? Consider the compliance cost to prove your position or being accused of tax avoidance, unpaid tax, late tax payment penalties, etc—a wide grey area to be aware of.
Taxation rules for property investors
In contrast to other industries the housing market has been and will always be in the spotlight because of its gravity for politicians, voters and just people who are looking for a place to live.
The property market is driven by emotions and suffers from high costs, dated housing and low rental yields. Landlords have always been good for taking the blame and also an easy target as scapegoats for bad resource or infrastructure management. Low rental yields and social contributions on behalf of tenants result in cloudy market rents and are difficult to compare with other nations. In countries, I am familiar with, consumer related fees like water levies and fees for council services are charged to occupants, not the title holder of the property.
A good example for driving the yields to zero and below are changes made in April 2010 by removing the depreciation on residential properties and the new definition of expenses, which are not rent income deductible. Let me illustrate.
Example for paying $237 tax despite of $2880 loss
Let me assume you let a three bedroom house for 390 Dollars per week. You still pay on a 200k mortgage 6% interests, 5k on levies, fees, maintenance – you could earn by 52 weeks occupation 3280 Dollars rental income per year. That is in theory because the average occupancy is only 49 weeks. That would reduce your annual profit to 2110 Dollars or monthly cash-flow to 175 Dollars.
Now, it is not unusual to happen that the tenant, who run into rent arrears, abandoned the tenancy. A damaged property, 4 weeks vacancy for doing repairs and finding new tenants are the consequences. In this example reducing the maximum taxable income ($3280) by 4 weeks rent (vacancy) the positive cash-flow would shrink to 1720 Dollars. Still positive you might think while the arrears would be covered by the bond.
With common sense the landlord considered to do home improvement work because of the accidental vacancy and scheduled tradies for repairs. Good thinking to take this opportunity to improve insulation, right? Well, here is the catch—home improvements are not rent deductable!
At the end of the story spending 3700 Dollars for house insulation resulted in negative cash-flow ($1980 loss). But still the landlord has to pay tax on 1720 Dollars on rental income. By holding the rental property in a trust (tax rate is 33%) the additional income tax would be 567 Dollars .
The only protection you have got is knowing the taxation rules. Don’t get caught paying tax when making loss.
Improvements are not rent-deductible
As landlord you can only survive if you plan improvements and work out the numbers before starting any renovations. Improvements have to be capitalized. But also know that for residential housing the depreciation has been taken away – in other words the landlord does not get paid for the work, the increased capital is with zero depreciation and there is no reimbursement for “wear and tear”. Only replacements/repairs are rent deductible!
Repairs which significantly improve the value of a property, let me say you replace a broken window with a new double glazed window, in that case you cannot claim these costs as a rent-deductible expense. That would be (again) a capital expense. For more download the IR 264 guide.
Watch out for “Negative Gearing”
Negative Gearing (negative cash-flow) as the result of increasing interest rates is a risk for an investor with low amounts of equity. Off-setting loss against income from different sources is a risky strategy as “Ring-Fencing” (taxation rules to avoid that) is not off the government’s agenda.
Currently NZ has already Ring-Fencing for anyone who is not holding investment properties in their own name or an LTC. For setting up an LTC (Look Through Company) that replaced the previous LAQC (Loss Attributing Qualifying Company) in April 2011 please take professional advice.
A new “2-years rule, enforced by Oct 2015” that defines income tax applied to capital gained. Actually, IRD’s ability to tax capital gain on investment properties has always been there. But the change makes it easier to draw a line between an investor and a trader/developer or speculator.
Frequent changes to taxation for property investors can make you succeed or fail. Know the rules in properties there is no “free meal” and don’t cross the line separating investors/landlords, developers/traders or speculators. Good luck
Property Investor’s Blog
Investor’s & Landlord’s Luck and Failure
Klauster Blogs lead to a real person, IT professional, investor, landlord and business owner with interests in technologies, properties and trading.
His passion, making experiences available and helping people like you, comes from extensive travelling and the principles of life—how to avoid pitfalls in unfamiliar territory when investing or forming relationships.
The philosophy to treat life, partnerships and hobbies as an investment has helped people in his circle. Life is a dream with a deadline, happiness comes from making the right choices and having realistic expectations.
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