Houses - To The Moon or Hell?

When I grew up, my parents taught me that property doubled in value every 10 years.

Judging by this graph below, they were pretty right.?

Just over 10 years ago, I started my first public practice accounting job. In that decade I have seen a number of changes to the property rules which, I think, over time, will have an impact on the value of houses.

MOST of these changes have been designed to?decrease?the appeal of a rental property as an investment. Some of the major ones have only been implemented over the last few years and are still being implemented.

When I first started out in accounting, it was the most fashionable time to have a rental property because people could literally game the system in the following way:

Have a rental property with a lot of debt stacked against it (using equity in their own home to secure rental lending) and claim something called depreciation on that property.

Depreciation is a non-cash expense that reflects an assets value decreasing. This was based on a percentage of the house value.

So people (Sally & Bob) would have a rental statement looking something like this:

Rental income $20,0000

less Expenses (accounting fees, bank fees, depreciation, insurance, interest expense, repairs, rates, travel (for inspections of course). = say $40,000

That means they made a loss of $20,000 maintaining their rental property for people to live in.

Sally and Bob would put a $10,000 loss into each of their tax returns and this would offset their PAYE income, meaning they’d get a nice refund as they'd paid too much tax.

Sally and Bob would use these 2 refunds to pay down the mortgage or repair the property. Repair the fireplace or curtains, for instance.

The key point here is to REPAIR the rental property and not improve it. As the repair is a tax-deductible expense, you can add to your expenses in the next financial year, isn’t it? Yes!

This repair would ‘without knowing’ (wink wink) increase the value of the property. If Sally and Bob were to sell the property (in a system where houses always increase - see graph above) they’d also make a capital gain on that rental property and not pay tax on that gain.

If Sally and Bob were smart they wouldn’t sell but they’d get another property and rinse and repeat the above.

OK, now you can see why property was so sexy.

Shortly after I started out in the big wide world (2011) of talking rental properties with clients, the rules got rid of claiming depreciation as that made no sense when all properties go up in value.

That was one expense gone. Note: you can still claim depreciation on the chattels of a rental property, so rental owners often get these valued.

In 2015, the rules changed again, kind of. They said that if you sold your rental property within 2 years, then you’d be paying tax. These were called 'bright line rules'.

But these rules didn’t do jack because people had been buying to hold for 10 years, weren’t they? That’s what their parents taught them to do!

These rules were subsequently extended to 5 years in 2018 and then 10 years in 2021. 10 years is more like it isn’t it? These rules exclude the family home, some new builds and a few others - always get advice when selling.

The bright line rules were there to make some people pay tax on gains on rentals. And they have captured a fair few people's sales and therefore tax.

Now, I need to take you back to 2019-2020 where new “ring-fencing rental losses” came in. This means deductions for residential properties are ring-fenced so they can only be used against income from that property.

In other words, from the 2019-20 income year, new ring-fencing rules mean people cannot use rental losses to offset other income like salary and wages.

No more putting the losses in ole Sally or Bob’s tax return to get a refund to repair the property. Daaammmit Sally and Bob said to their accountant.

This was actually a pretty big change because the loss would just carry forward to more profitable rental years.

Now another big change in 2021. Remember our expenses above? Well now we’ve said to Sally and Bob that you can’t be claiming your interest as a tax-deductible expense going forward as it will be fazed out.

For residential rental property purchased on or after 27 March 2021, interest cannot be claimed as an expense from 1 October 2021, unless an exclusion or exemption applies.

This is the first year of completing sets of rental accounts (in the 2022FY ended 31 March 2022) where people aren’t able to claim 100% of their interest expenses. People can still claim a % but it is being decreased over the next 5 years. Any loss is carried forward.

In 10 years, I've witnessed some pretty major changes to rental property tax rules. The major ones are only really a couple of years old, so they will take some time to have an impact.

Whether these will slow down the excitement of investing in rental properties is yet to be seen in true data, but the rules of the game have changed and the ‘property doubles every 10 years’ chat may still be a thing due to other reasons (kiwis obsession with home ownership and 500 likes on social media when you buy a home) but the benefits of rental investing aren’t there like they were 10 years ago.

Of note is the fact that interest rates are a lot higher now and debt levels too. Buying a rental now has fewer tax incentives attached to it, but it’s also harder. Losses (higher interest) will be larger and servicing of debt harder. You may be able to use those losses (carried forward as we learnt) to offset any gains triggered when selling (under the bright line rules).

This email isn’t to tell you property is a bad investment, it is to teach you that, just like sport, the rules can change.

You may not like tax and accounting, but you need to understand the rules that govern the sport of property because, for a long time, it has been Kiwis favourite.

There are always fine details with any tax situation, so don’t treat the above as tax advice or email me to tell me I forget to mention some minuscule rule people wouldn’t have cared about.

For younger people, the next time your parents ask you why you haven’t bought a house yet, ask them why didn’t they buy 3 given it was stacked in their favour and they all knew they’d double every 10 years?

I hope that this has given you a good understanding of property changes over the last 10 years. There are more but this will get you thinking about the key changes.

Mikey and I sat down and recorded a podcast on these rules plus some other things pushing back against housing and you can check that out here:

https://open.spotify.com/episode/64NIicwSn6eEgbXQx2Y3BN?si=mSEdpmBaT4SyktnrVDMl7

Point to ponder: over the last few decades, real estate and mortgage advisory have been great careers to get rich in. The income for both of these roles is based on a % of the property sale or the debt needed to finance one.

Because house prices have increased faster than the cost of living (food, housing etc.) these people have been able to get ahead faster than other jobs. Of course, you still need to be good at it.

Finally, property values as per that graph above look exciting, but remember what underpins them. DEBT! House prices have gone up, mortgages to buy them have too.

Have a proper(ty) weekend. Poor Dad joke.?

Luke