Tax trap in '$1000 down' flats
By GREG NINNESS - Sunday Star Times | Sunday, 17 June 2007
Tax experts and lawyers are warning investors of the potential dangers of buying residential investment properties "with just $1000 down".
Such arrangements have become fairly common during the recent property boom, usually promoted by developers selling apartments "off the plans" before they are built.
The projects are often extensively advertised with the line that investors can buy a brand new apartment "for just $1000 down".
This usually involves the investor borrowing the entire purchase price, plus a bit more, and securing the lot with a mortgage over their existing home as well as the apartment they are buying.
The investments are usually loss making and interest payments on the mortgage and other costs are far more than the rental income the apartment eventually generates.
Those losses can cut investors' tax bills, which in turn can cut their cash loss each week, but even so, they may still have to dip into their pockets each week to make regular payments to keep the scheme afloat.
The short-term pain of a cash loss is balanced by an expectation that property prices will continue to rise and they will be able to make a substantial capital gain a few years down the track.
But investors should not assume the capital gain would be tax-free, said Jo Doolan, a tax partner at accounting firm Ernst & Young.
"The tax-free status of the capital gain in such arrangements would have to be seriously questioned," she said.
This is because the investment always runs at a loss and never provides the investor with an income, which implies they bought it with the intention of selling it for a profit. "And that's exactly what the government gave the IRD an extra $14 million for in the budget, to crack down on that type of thing."
Doolan also warns that such investors would be at serious risk if the government changed the tax rules which allow the losses they produce to be offset against other income. This is usually a central component of such schemes as it reduces the cash outgoings the investors have to pay each week.
If the rules were changed, investors could suddenly find themselves shouldering a higher portion of the losses and a corresponding drop in their weekly income.
Grant Pearson, a partner with law firm Duncan Cotterill, described this possibility as "quite scary" for some investors because of the large amounts of money they had borrowed to fund their investments.
If the rules were changed, "they could find themselves in quite a bit of difficulty and it could get pretty ugly, because the numbers are quite large", Pearson said.
But Carl Gray, manager of LJ Hooker Development Services, a real estate agency which sells many investment properties, is not worried by such talk.
"Well, how quick do you think the government is?" he asks.
"It takes them 20 years to do anything. So how long will it take to change (the tax rules)? We don't know, but I'd suggest it would take a fair while."
Doolan sees a closer horizon.
"While it's highly unlikely they'll deal with it before the next election, it's still on the agenda to be looked at," she said.
Doolan also says investors should be cautious about a property's value when buying off the plans, even when it is supported by a registered valuation. Some investors have been burned when they have had to resell at a loss.
By GREG NINNESS - Sunday Star Times | Sunday, 17 June 2007
Tax experts and lawyers are warning investors of the potential dangers of buying residential investment properties "with just $1000 down".
Such arrangements have become fairly common during the recent property boom, usually promoted by developers selling apartments "off the plans" before they are built.
The projects are often extensively advertised with the line that investors can buy a brand new apartment "for just $1000 down".
This usually involves the investor borrowing the entire purchase price, plus a bit more, and securing the lot with a mortgage over their existing home as well as the apartment they are buying.
The investments are usually loss making and interest payments on the mortgage and other costs are far more than the rental income the apartment eventually generates.
Those losses can cut investors' tax bills, which in turn can cut their cash loss each week, but even so, they may still have to dip into their pockets each week to make regular payments to keep the scheme afloat.
The short-term pain of a cash loss is balanced by an expectation that property prices will continue to rise and they will be able to make a substantial capital gain a few years down the track.
But investors should not assume the capital gain would be tax-free, said Jo Doolan, a tax partner at accounting firm Ernst & Young.
"The tax-free status of the capital gain in such arrangements would have to be seriously questioned," she said.
This is because the investment always runs at a loss and never provides the investor with an income, which implies they bought it with the intention of selling it for a profit. "And that's exactly what the government gave the IRD an extra $14 million for in the budget, to crack down on that type of thing."
Doolan also warns that such investors would be at serious risk if the government changed the tax rules which allow the losses they produce to be offset against other income. This is usually a central component of such schemes as it reduces the cash outgoings the investors have to pay each week.
If the rules were changed, investors could suddenly find themselves shouldering a higher portion of the losses and a corresponding drop in their weekly income.
Grant Pearson, a partner with law firm Duncan Cotterill, described this possibility as "quite scary" for some investors because of the large amounts of money they had borrowed to fund their investments.
If the rules were changed, "they could find themselves in quite a bit of difficulty and it could get pretty ugly, because the numbers are quite large", Pearson said.
But Carl Gray, manager of LJ Hooker Development Services, a real estate agency which sells many investment properties, is not worried by such talk.
"Well, how quick do you think the government is?" he asks.
"It takes them 20 years to do anything. So how long will it take to change (the tax rules)? We don't know, but I'd suggest it would take a fair while."
Doolan sees a closer horizon.
"While it's highly unlikely they'll deal with it before the next election, it's still on the agenda to be looked at," she said.
Doolan also says investors should be cautious about a property's value when buying off the plans, even when it is supported by a registered valuation. Some investors have been burned when they have had to resell at a loss.
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