A capital gains tax is not the only measure that can be taken to help cool an overheated property market, and it’s not even the only possible tax measure. There are other tax based steps that could be taken. Nevertheless, on cue, up popped the Minister of Housing to claim that property investors are already subject to tax (interview on Morning Report, at 6.48). The unspoken conclusion is that therefore, no other tax based measures are required.
So is it true that property investors are already taxed?
Well, yes. But it’s not quite as true as Nick Smith and the Property Investors Federation would like it to be.
Residential property investors pay tax on rental income, much as any other business pays tax on their sales income. They get to claim expenses, such as interest, rates, repairs and maintenance, insurance, management fees, and so on. That’s all regular and routine, and it’s not really the focus of the discussion around capital gains.
What is really at issue is whether property investors pay tax on the gain on sale of the houses they own. We see this issue when people say things such as, “New Zealand already has a capital gains tax.”
So do property investors pay tax on capital gains?
Yes, and no.
Under New Zealand tax law, if you buy something with the intention of resale, or if you are in the business of trading in something (eg. electrical goods, baked beans, cars, whatever), or you’re in business in general (architects, lawyers, plumbers, whatever) then you are caught in the income tax net. (Income Tax Act section CB1, CB2) There are some specialist rules around buying and selling land (section CB6 ff) but the major effect of these rules is to reinforce the basic rules: you get taxed on gains on sale if you acquire something with the purpose of resale, or you’re in business.
For example, if you hold a portfolio of shares, and you acquire them for the purpose of dividend income, and you hold onto each parcel for a long time, and you don’t engage in buying and selling shares on a regular basis, then those shares will look like a capital investment, and any gain on sale won’t be caught in the income tax net, should you sell any of them. On the other hand, if you regularly buy and sell shares on the stock exchange, then chances are you will be regarded as a trader, and you will end up paying income tax on any gains on sale.
A more down to earth example: imagine that you spend your time scouting around garage sales and second hand stores, spotting bargains and snapping them up, and then reselling them on Trade Me. That might look pretty much like acquiring something with the intention of resale, or being in the business of buying and selling, and IRD will be asking for its share of your gains, or profits.
So when people claim that New Zealand already has a capital gains tax, they’re sort of right.
But really, they’re wrong. We have a tax on people who are in business, or who acquire something intending to sell it. What we don’t have is a tax on the gain on sale of assets like rental houses and farms and business premises that were NOT bought with the intention or resale. So there is no thorough going tax on capital gains in New Zealand.
You might try to argue that of course, if someone buys a rental property, then obviously they intend to sell it at some time in the future, and so the gain on sale will be taxable.
But, it’s not so obvious. If you buy the property, and hang onto it for a long time, and you find tenants for it and rent it out, then it very much starts to look as though you bought the house with the intention of earning rental income from it. And that means that although the rental income is assessable, the house itself gets classed as capital, and so any gain on the sale of the house is not subject to income tax.
You could even try arguing that the property owner’s real intention was resale, and holding the property and renting it out was just a cover-up. But in order to police that, IRD would need the ability to get inside people’s minds. Thankfully, they don’t have that power. IRD has to go on what people actually do, based on documentary evidence. And the evidence in this case points to the house being a capital asset, and so not subject to income tax on sale.
So if you’re a property investor who buys and sells houses regularly, then yes, you will be subject to income tax on those gains on sale. But most property investors buy and hold and rent out their properties. The properties are capital assets, and so any gains on (long delayed) sales fall out of the income tax net.
And that’s why it’s just a bit disingenuous to claim that property investors pay tax already. Yes, they do. Just not on the huge capital gains they make that comprise the bulk of their increase in wealth.