Tax changes would slash house prices

A capital gains tax would reduce house prices by 10.9% while taxing property investors on a deemed rate of return would cut them by 19.5%, Westpac estimates.

Tuesday, June 19th 2018, 9:00AM

by Miriam Bell

Westpac chief economist Dominick Stephens

The Government’s Tax Working Group is currently working on its interim report into possible changes to New Zealand’s tax laws and whether some of those changes could impact on house prices.

While the TWG’s final recommendations are not due until next February, it is widely considered that the introduction of a capital gains tax is likely to be one of the recommendations.

Given the perception that property investors have tax advantages, there is a high likelihood that the TWG will recommend other tax changes directed at property investors.

Now Westpac has released an analysis of whether various property tax changes would have an impact on house prices – and its conclusion is a resounding “yes”.

Westpac chief economist Dominick Stephens says New Zealand’s property prices are profoundly affected by the tax system.

“It follows that changing the tax system would change property prices. It would also change the rate of home ownership.”

That’s because property is more lightly taxed than other forms of investment, he says.

Treasury and the IRD estimate that property investors pay 29.4% of their after-inflation returns in tax, whereas bank depositors and owners of dividend paying shares pay 55.7%.

Stephens says this is mainly because income from investments is taxed, whereas capital gains are tax free. Additionally, expenses, including mortgage interest, are tax deductible.

“This feature of the tax system is especially useful for property investors, who find it easier to borrow against their investments than other businesses.

“It has made property investment incredibly popular. And that popularity has been one factor pushing house prices higher.”

Further, property investors enjoy more favourable tax treatment than heavily indebted owner occupiers, he says.

As a result, investors are willing to pay more for properties and fewer owner-occupiers are able to outbid them - which has contributed to the fall in the home ownership rate.

“If the tax system has affected the price of property and the rate of home ownership in New Zealand, it stands to reason that further changes to the tax system could once again alter both,” Stephens says.

Westpac’s analysis suggests that various tax changes would have the following impact on house prices:

• A capital gains tax of 10%, which exempts the family home, would reduce house prices by 10.9%.

• A property tax of 0.5%, calculated as a percentage of the value of the property (including the land and the house), and exempting the family home, would reduce house prices by 10.5%.

• A land tax of 1%, again exempting the family home, would reduce house prices by 9.5%.

• A deemed rate of return tax - whereby IRD would assume investors were earning a 5% return on the equity in their rental properties and levy income tax on that return – would reduce house prices by 19.5%.

But the analysis notes there is no indication of how long such adjustment in prices might take to play out.

There could be a sudden drop in prices or a long period of price stagnation while the fundamentals catch up.

Westpac’s analysis also looks at the Government’s looming changes to the rules around the ring-fencing of rental losses.

Stephens says these changes won’t impact on investors who have positive cash flow but they will impact on those with highly leveraged portfolios.

“For an investor running a property portfolio with 65% debt and 35% equity in perpetuity, we estimate that ring-fencing will reduce the value of the investment by 6% - although the impact could be smaller.”

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