Capital Gains Tax – what does it mean for you?
On the 21st February 2019, the Tax Working Group recommended that the government implement a capital gains tax. We spoke to Garreth Collard from Epsom Tax on some of the possible implications and strategies going forward. But first a bit of a summary.
What assets were recommended to be taxed?
The recommendation from the Tax Working Group is that assets such as land, shares, investment property, business assets are taxed so that any gains from April 2021 onwards would be paid at the owners standard income rate upon sale of these assets. At this stage, there is no intention to tax capital gains on a personal home.
It’s possible (even likely) that some of those assets will be removed from the final tax policy but if Capital Gains Tax goes ahead, in our opinion, it’s almost certain that investment property will be included.
What are some strategies for dealing with Capital Gains Tax?
Garreth: The Valuation on 1st April 2021 is a firm line in the sand. From there, gains are taxed. It could be a reasonable strategy to renovate investment properties in the next couple of years to get that value as high as possible.
This is an excellent strategy which isn’t immediately obvious. Assuming property is part of your retirement plan, any improvements you can do before April 2021 will essentially be tax free. It makes sense to push that line in the sand as far ahead as possible to save on future capital gains tax.
Tip: you don’t have to prove the value prior to April 2021 (you have up to 5 years to prove the value); but proving the value means you can choose to sell without rushing through a Valuer. We would recommend valuing the property within the first 3 months to keep your options open.
Implications for retirement
If property is still a major part of your retirement expectations, you wouldn’t necessarily abandon your plan because of the Capital Gains Tax. You should, however, alter your calculations. If you have budgeted for 5% capital growth per year, then this would now be around the 3.35% (post-tax).
While this is unfortunate, remember that property is still a leveraged investment. In other words, if you have $120k of cash, you can purchase (as of today) a $400k investment property. If that investment property grows by 3.35% after tax, you have made $13,400. You would need a savings account on a 11.2% post tax interest rate to match this in the bank (which seems unlikely at any point in the future).
One unintended consequence from a Capital Gains Tax could be that investors simply hold their properties and pass them down to family members in their Will. At the moment there is no inheritance tax in New Zealand. While this is a possible outcome, it would seem that eventually the property will be sold at which point the difference between the purchase price (or April 2021 value) and the sale price would be taxed.
How the government dealt with the eventual sale of the property would be clarified in future policies.
Implications for borrowing against investment properties
The implementation of a Capital Gains Tax is going to complicate using equity in investment properties. Let’s imagine the year is 2025 and your property is worth $1m. Today, you could borrow up to 70% on this investment property and use that money to purchase further investments.
But in 2025, the question will be how much tax you are liable for upon the sale of that property. So the first question the bank will ask is, how much was that property valued at in April 2021. If it was $700k then you are liable for around $100k of Capital Gains Tax (leaving an actual post tax value of $900k).
It would seem likely that the bank will calculate their LVR based on the post-tax number rather than open themselves to the possibility of their clients being “under water” on their tax bill.
Garreth: Retirement savings are going to be hit the hardest by the Capital Gains Tax. A good property strategy is always about buying and holding and a third of that will be now given to the government. It is important to remember that these are just recommendations at the moment. It’s possible that properties could be taxed at a flat rate – for example 15% – like it is in Australia.
Is property still a good investment for retirement?
- The immediate discussion in the media seemed to indicate the fear that investment property owners would liquidate their assets and seek better investment opportunities. This would result in a flood of properties onto the market and a drop in house prices.
This seems like an unlikely scenario – mainly because of the leveraged borrowing that property still provides (as above). There are not many other investments that you can easily borrow up to 70% of the value of.
Other strategies to deal with Capital Gains Tax
If you own an investment property today, now is the time to get a plan in place for the possible Capital Gains Tax. Some things you will want to discuss are:
- mortgage structure (talk to your bank or mortgage adviser)
- the ownership of your property – in a Trust, LTC or your personal name (Accountant and Lawyer)
- possible improvements to your property (a builder)
Garreth: It is always a good idea to pay off your mortgage. But now more than ever is a good time to get your mortgage to the point that your property is cashflow positive. This will mean the strain on your personal cashflow is reduced and your retirement will look even better.
At this stage, it’s important not to make any hasty decisions. Talk to your team of professionals and make a plan.
Blog written by Rupert Gough. No information in this article should be taken as personalised advice. Seek professional advice on your personal situation for clarity.
Special thanks to Garreth Collard for his time working with us on the Capital Gains Tax report. You can read Garreth’s blog on the Capital Gains Tax here.
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