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The IRD giveth and taketh: Terry Baucher reviews the risks of relying on tax benefits to invest in property

The IRD giveth and taketh: Terry Baucher reviews the risks of relying on tax benefits to invest in property
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By Terry Baucher*

Matthew Gilligan's forceful argument in support of residential property over renting can be summarised as follows:

"The capital growth on houses is not taxed. This gives home ownership another obvious advantage, coupled with the benefit of bank leverage. It is leverage at good growth rates, plus a better tax profile on the capital profits, that really stand the property ownership model up as a winner."

A significant number of Kiwis agree with Matthew according to Reserve Bank statistics.

In 2013 the Reserve Bank estimated the total value of housing to be $717 billion, or 2.7 times greater than the estimated $267 billion held in financial interests such as bank deposits, superannuation schemes, shares and bonds.

But how much of this housing represents residential rental property?

There doesn't seem to be a lot of publicly available data. In a 2009 report for the Tax Working Group, Inland Revenue estimated the value of residential property investment as $200 billion, about a third of the Reserve Bank's then $605 billion valuation for housing.

To find out more, I asked Inland Revenue for details of the total numbers of taxpayers who returned residential rental income.

I also requested a breakdown by entity class of the total rental profits, total rental losses and total net rental income.

Inland Revenue happily obliged with details for the years ended 31st March 1997 to 31st March 2013 inclusive.

The data makes for some fascinating reading. It clearly demonstrates the effects of tax policies over the past 15 years and, although incomplete hints, at how leverage is used tax effectively.

The data also makes apparent why Inland Revenue really, really, really, didn’t like loss attributing qualifying companies (LAQCs).

According to Inland Revenue the total of individuals, trusts, partnerships and companies (including LAQCs) returning residential rental income for the year ended 31 March 1997 was 138,000. By the year ended 31 March 2011 that number had risen to just under 245,000.

It's when the split between the types of investing entities is examined that it gets particularly interesting. From the 2000 year onward the numbers of companies (including LAQCs and trusts) involved rise much more quickly than for individuals and partnerships.

The number of companies returning residential rental income rose twelvefold from 2,400 in March 2000 to a peak of 29,800 for the March 2011 year. Similarly, the number of trusts returning rental income in the same period more than tripled from 7,200 in March 2000 to a high of 22,900 in March 2011.

By contrast the number of individuals and partnerships returning rental income rose from 158,800 in March 2000 to 192,200 in March  2011, a gain of just over 21 %.

The rapid rise in the number of companies and trusts returning rental income coincides with the increase in the top individual tax rate to 39% and the tax advantages each structure offered.

For tax purposes trusts are separate taxable entities with a maximum tax rate of 33% on retained income. This is very useful when the top income tax rate was 39%. Depending on the terms of the trust deed, income can be distributed at the trustees' discretion to beneficiaries who might have a lower income tax rate (19.5%  for much of the 2001-2009 period).

Companies also had a top rate of 33% for the 2001 to 2007 years, and then 30% for the 2008 to 2011 income years. However, LAQCs had the advantage of being able to pass any losses through to their shareholders. This made them exceptionally tax efficient: profits were taxed at 33/30%, but losses flowed through to shareholders and therefore effectively could offset income which would otherwise be taxed at 39%.

From 2001 onwards there was aggressive marketing of residential property investment during this period by the likes of Blue Chip.

The schemes promoted by Blue Chip and others sold residential property investment as a zero-cash cost deal. Investors would leverage off the equity in their existing homes to invest.

The maximum possible depreciation of the investment property and its fixtures and fittings was claimed to maximize the available tax deductions. This way the combination of tax refunds and rental income was meant to cover the interest and other running costs.

Simultaneously, there was a remarkable growth in lending after 2000.

According to the Reserve Bank loans from banks and other lending institution rose from $73.7 billion in 2000 to $180.1 billion in 2009. Most of that additional lending was for residential property.

But despite the growth in the number of investors and the amount of funds flowing into residential property, the amount of taxable rental income returned starts falling after 2005.

This decline in net rental income from the year  ended 31 March 2005 onwards can, as the New Zealand Property Investors Federation argued in relation to the 2009 year, be explained by the increase in interest rates as the Reserve Bank tried to control inflation.

On the other hand, the decline in rental income is also a sign that many investors were heavily leveraging themselves to invest. This becomes more apparent when we look at the returns from companies which shows an even more marked fall.

Companies reported net tax losses for each of the tax years from March 2007 to March 2011 inclusive. Over that five year period the losses totaled $1.24 billion, or nearly $250 million each year. By contrast 2009 was the only year in which individuals reported a net loss ($170 million), while trusts and partnerships never reported a net loss in any year.

As LAQCs were also a prominent feature of the Trinity tax avoidance scheme, Inland Revenue, as you can imagine, didn't like how they were being used. Its 2008 Briefing to incoming minister specifically noted the use of companies and trusts to shelter income from the top rate of tax as a risk to the tax base.

It should therefore have come as no surprise when Inland Revenue moved in 2010 to end the use of LAQCs and remove the ability to depreciate buildings.

The effects were dramatic: net rental income returned rose from $250 million for 2011 to $1.29 billion in 2012 and $1.47 billion in 2013.

The changes from the 2012 income year have prompted a shakeout of investors with the numbers of companies, trusts and partnerships reporting rental income declining in both the 2012 and 2013 years. Some of this is down to individuals deciding to hold investment properties in their own name.

Others have converted their LAQCs to look-through companies (LTCs).

In this context it’s interesting to note that LTCs returned a net loss of $10 million for the 2012 year and no net income for the 2013 year. This suggests that such entities are still heavily leveraged.

Residential property does undoubtedly have tax advantages but as this article demonstrates tax advantages come and go.

What really matters are the investment fundamentals.

Pay attention to those and any tax benefits should be the icing on the cake, not as often seemed to be the case last decade, the main driver for investment.

This is my final column for 2014. I'd like to thank David Chaston and Gareth Vaughan for giving me the opportunity to ramble on about tax throughout the year. A big thank you also to the many readers who commented on or emailed me about an article. I trust you all have a very Merry Christmas and best wishes for a Happy New Year.

The full  information provided by Inland Revenue will  shortly be published on my website


*Terry Baucher is an Auckland-based tax specialist and head of Baucher Consulting. You can contact him here »

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Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.


There must have been some massive losses filed by the end of 2007 to get the net income from all NZ rental property to go negative (considering most rental properties would have been bought and largely paid off and returning solid profits up to 2000).

Big building depreciation numbers dreamed up together with highly leveraged purchasing of  low yielding over valued property in 2007 (as is now the case today in auckland) against high interest rates (10% plus floating) all combining to push the net rental income negative.

The thing is, if investors could handle the losses or lack of income seen during the later half of the last cycle, and considering the much healthier cash flow over all at present levels, how much scope still exists for investors to leverage up from this point?  Esp given the massive equity increases seen in auckland over past 3-4 years.

Or was it only the paper expenses of depreciation that make the cash flow seem so poor in 2007-2009? Which ironically actually improves cashflow as it leads to a tax refund...

Any way of drilling down further to get figures on the depreciation on buildings claimed up to when it was abolished?




"(considering most rental properties would have been bought and largely paid off and returning solid profits up to 2000)"


Not at all. One could assume that most of the rental stock was only purchased between 1997 and 2011.  I know of a residental rental property constructed in 2000 that didn't make a profit until at least 2012.


"According to Inland Revenue the total of individuals, trusts, partnerships and companies, (including LAQC's) returning residential income for the year ended 31 March 1997 was 138,000. By the year ended 31 March 2011 that number had risend to just under 245,0000."


The numbers obviously don't show the breakdown of total dwelling numbers just those entities invested in them.



I asked this elsewhere yesterday, apart from the absolute dollar value, what benefit does anyone see in handing elevated interest payments to banking corporations rather than paying tax?

It seems to me that this is the single ultimate outcome of this structure. To create a situation where you deliberately pay one expense in order to avoid another seems a bit silly. For that misdirection to be away from the benefits we could all receive locally from the payment of tax on income generated, infavour of lining offshore pockets with higher interest payments to incur a loss seems all the more bizarre.

I haven't run the numbers to know, maybe someone can give an illustration of the actual dollar amount outcomes to negatively gear a median property against a highish income showing how much tax would be missed and how much this is shuffled to bankers?



yes you are replacing tax with interest when you leverage up to the point that you make a loss.  So in that regards you don't gain anything.  But you are missing the elephant in the room, untaxed capital gain.  The more you leverage the greater the gain, and the tax offset just makes it more affordable.


Leverage gives increased profit .... over short holds.  
much of this is basics but included for illustration of the patterns.

If I buy $1,000,000 asset (ANYTHING, not just property) and I pay $1,000,000 cash.
asset 1m   , cash -1m.  
assuming we're doing this for investment then we will expect some sort of generated revenue stream.  lets go with a nice simple 5% gross per annum.
so thats $50,000 revenue.   50,000 / 1,000,000 = 5% yield , pay your tax, keep 35,000.  but it cost you 1,000,000 to get that 35k.

So lets say you pay $1,000,000 and get a $2,000,000 asset.  Ok you have to borrow 1m to do it.   We'll go for a place that has same yield rate. 5%. = $100,000 revenue. but you have to pay interest 6%.  6% on $1,000,000 = $60,000. $100,000 - $60,000 = $40,000. pay your tax, keep 28,000,  it still cost you 1,000,000 to get the 28k.   That's as far as most people can see. You pay more but paying interest you get less back.

But in 10 years, version a, you'll have 350,000 revenue.  but in b, reinvesting you'll have >280,000 increased equity... and your interest is 6% of 720,000 = 43,200.    5% yield = $100,000 - 43,200 = 56,800.  less tax = $39,760.  same property but now giving 10% more than orginal.

If you compound invest the 350,000 from the first example you'll do better, because you're not losing that 6%.

If the asset itself holds or increases value against inflation or the market holds value.
assume 2% p.a. compounded

The $1,000,000 in 10 years is now worth $1,218,994.  Rent review = 60,949 gross predicted revenue.  In the first example you have nothing to pay off so $ 60,949 less 30% tax = $ 42,664

The $2,000,000 in 10 years is now worth $2,437,984.  Rent review = 121,899 gross. As mentioned previously we've been deleveaging this asset pool with incoming revenue, so debt is $ 720, 000 @ 6% = 43,200 interest.  5% rents = 121,899 - 43,200 = 78,699 less 30% tax = $ 50,089 so we're still well ahead of the 100% equity situation, and accelerating.

Plus if we liquidate the stored equity, our $1M investment gets $ 218,994 + revenues = 568,994 gross.  
But the leveraged situation gets $ 1,437,984 - loan =717984 gross for the same initial $1M over the same period.  And that's what hooks many property investors.... 

But you know all that.
but lets say you only have $500,000 inheritance, and the best deal you can get is 7%
You could sink it all into a single $500,000 investment and pray there's no large expenses and possibly get 5% = 25,000 less tax = $17,500    which is pretty much my current situation, and that's not really enough to live on and reinvest.  (except mine isnt inheritance 'cause the 'rents ain't ded).  The $500,000 in 10 years has incresed value @2% compounded = 109,974 + 175,000 = 284,974 which is pretty sad return for 500k in a decade.

Using basic leverage. $1M, $500k down, $500k@7%.  50k gross rev. 35k interest. 15k (yeah don't get excited) PRE-tax income = $10,500 to pay off debt.   Note though the outside environment factors STILL give the same 218,994 capital stability.  So if we release the equity in 10 years we have 1,218,994 - debt 395000 = 823,994 - 500,00 seed money/ante = 323,994 return, which is a bit better.  this is because the capital value holding against inflation is the nature of our investment, not of the money we're putting up, likewise the rents(returns) are based on the asset value, not what we put in.

But lets try second example.
Buy $2M property.  you'll be paying 7% on $1.4M = 91,000.  5% is still $100,000 rev. but now we're paying 105,000 in interest. Oh noes!! that means ownership loss of 5k per annum!  Where is that going to come from?    Same as any investment, the owner has to pay it,  so just like a compulsory savings scheme, or kiwislaver, or superannuation scheme, the owner regularly inputs 5,000 / 52...let's say 100/week.  Like any investment loss, this 5,000 p.a. counts against ones personal revenue (normally wages.)
 ** Income is revenue - expense  (ie what is available for discretionary consumption of distribution)
So that's a annual loss for 10 years, with interest locked 10yrs at 7%, and returns at 5%. inflation still at 2% coumpounding.

The $2M property, has same environmental holding power = 437,988.  Gets same rents as a fully deleverage neighbour w/ $2M invested, 5% = 100,000.  As discussed interest is 105,000. giving revenue of 5,000 LOSS, made up by owner.  tax is $0, and will result in refund of $1,500 (which we're going to reinvest to reduce loan)
In 10 years, the minimum negatvie leverage situation,  release the 2,437,989 in the asset. less 1485000 loan = 952,988 - 500,000 input = 452,988 which is not bad on 500k even in 10 years.  but we do have to deducted the 5,000 p.a. regular investment * 10 years/  giving 402,988.

402,998 increase vs 323,994 (basic leverage) vs 284,974 (fully funded)
Not bad but negative gearing is very risky.  Change the interest rates or expenses, or have tenant issue, in negative gearing EVERYTHING comes out of your personal holdings, or attracts higher interest debts which quickly eat into profits especially if held over years.

Looking at the numbers it might be thought that leverage and negative gearing is perfect for speculators trading for capital gain.  This is very TL;DR so I'll post a 25 yr position, and a 10 yr one where the negative gearing inputs 50% to deleverage the cost.



5% rent 10 yrs
5.05% rent next 10ys
5.1% rent nest 10 yrs
2% inflation compounding
interest 7% 10yrs
interest 8% next 10 yrs
interest 6% next 10yrs

500k fully funded
10yrs = 359,497
20yrs = 747,973
25yrs= 957,803
(my own little guide figure, "wealth ratio" returns in 10 yrs:20 yrs is 2.081; returns in 10:25yrs is 2.664)  thus we can see a growth and acceletation of relative wealth.  this is the effect of the compounding, especially that of time vs inflation.

1M half funded
10yrs = 426,241
20yrs= 985,947 (loan paid off) @ yr 20)
25yrs= 2,466,106    not bad eh?

2M negative geared
10 yrs = 423,714  (not much fun after 100 wk deposit)
20 yrs = 765,556 (notice the shift in interest has cut into the return, because with negative gearing at low levels the investor is exposed for long periods)
25yrs = 1,393,193 seems bad doesn't it.  And with minimum negative gearing it is, thats because the banks make a much longer larger profit.

lets put in an extra 8k a year, although this is capital investment so doesn't attract tax reduction like the covering of interest expenses.
2M negative geared with capital subscription
10 yrs = 454,245
20 yrs = 960,078
25yrs = 1,600,986 Slightly better.
Whats killing this is that 8% interest rate.  And it's a similar effect to costs inflicted by government on people and businesses.  
   the negative gearing gets us into the bigger investment but the 30% tax recovery benefit is miniscule compared to the required productive rental return. 1500 refund vs 100,000 rent
 The real power of the negative gearing is that we can increase our inital investment like we would with a superscheme or other unit investment... so if we don't have 1M to enter into the 2M opportunity we can pay it down over time, preferably getting out of that negative zone asap.  And we can do this without having to look for new opportunities(risk).
  On a personal note, this is actually the position my parents have got themselves into with a commercial property by being negative geared. 10 years later, they realise the leveraging loan hasn't really dropped as fast as they'd expected and since post-GFC prices are slow, the CG hasn't really done well.  That's why they're now looking for lump sum methods to reduce the loan.... 
So negative gearing is a bonus, leverage works but at the end of the day, profits are profits and cash is king.    25yrs is a long time to (1) tie up 500k, and personally sacrifice to contribute 13k pa

I could cherry pick you a couple examples where the rent, cg and interest move better (like in Auckland at the moment)

but as you can see anyone using negative gearing is certainly not speculating in shortterm holdings!

Obdisclaimer: I'm not a investment professional.  these numbers are chosen for demonstations purposes and as such excluded many very real risks and opportunities.  It is _absolutely_ vital you seek expert local help with knowledge of the investment type you are doing and your own personal situation, and that you give them full disclosure.
Do not under any circumstances, use this example alone to guide your investment decisions!


There's another lesson to be drawn from this quite fascinating article: one that the various well-intentioned politico types would do well to ponder over the coming month's hiatus.


  • apparently small differences in incentive can have quite large behavioural effects.  A classic arbitrage example related to me by one of the perps:  two EU countries had slightly different allowable moisture contents for baled wool.  So the business model was:  buy wool in the lower content country, by weight.  Run a hose into the bale and check the content.  When moisture content equal to the higher country amount, ship it across the border to aforesaid country and sell it by weight.  Nice work if ya can get it.
  • lawyers, entities, people incentivised to do so, can move much more quickly than can Gubmints.  Look at that decline in entities filing, once the LAQC gate was opened, and the rebound once the shepherds noticed the gap and closed it.  For an offshore example, look at how ObamaCare casualised the workforce:  a full-time worker was defined as 30 hours per week or more and attracted ACA attention, so overnight, a host of FT jobs transmogrified into 29.995 hour PT jobs, with effects on household earnings and stability in general that are still working through the US economy.
  • lawyers, entities, people incentivised to do so, can spot gaps and loopholes long before the ponderous mechanisms of cases brought and heard can adjudicate them.  This is simply another type of arbitrage which has existed for a very long time, but which is routinely ignored by the well-intentioned because it is too painful for them to have to believe that a significant portion of humanity can be that way.  Early on in the computer world, it was rare for a company to last 18 months:  they would quietly shuffle off into the sunset, open up at the next sunrise with a different name, same staff, same premises, but oh, no, can't honour that old 3-year guarantee as the company doesn't now exist...

A great and informative article....


Sad part is not only can those people "spot" the gaps, often their very survival requires them to find and use them


or is it the "wide boys"?  ie the cute middle men making a buck off others. So quite why should we care about their survival?  I dont, I care about the farmers, end users, the ones making and consuming the good in a genuine relationship, but not  parasites.


their is self-selection bias because LAQC's aren't used by everyone... there's not point if the property is expected to have positive returns.... so LAQC's is the exclusive domain of the negatively geared

LAQC is nothing bad wrong or avoidance....

gods you people make me suicidal with your constant stupidity..

all that an LAQC does is allow losses that would be privately attributable ANYWAY, to collective ownership.

The basic tax system lacked any way for collective or share based ownership to handle losses - including family or trust or succession multiple ownership (where an single or group of assets could be purchased as with group ownership rather than a single settlor or donor)

If the property was owned privately then ALL THE LOSSES would have naturally been claimable ANYWAY.  But what happens if a family owned something as a joint collective, or several individuals, or individuals and trusts combined.  Who gets the losses, especially if they are expect to be several years long?   Easy, use the LAQC to proportion out the losses in exactly the same ratio as the ownership is, and therefore each person claims the losses that they would have got if they privately owned that much of the asset!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!


Wasn't it just the use of a company or trust when a profit was being made to pay a lower tax rate instead of 39% (when top rate was 39%).  I think the unfair thing about the LAQC's was that a loss could be refunded (potentially) at 39% rate (if an owner was in this tax bracket) yet once profit is made tax paid was at less than this rate. Trusts only had an advantage when the trust tax rate was lower than the top income tax rate (no longer true), and you can't claim trust losses against personal income (but can obviously carry them forward), so thats why property in trusts never returned an overall net loss.


Lots of agendas here but the one point that resonated is that in the quest for reducing ones tax under Cullens envy .39 tax rates, most savings made were simply paid as interest to foreign banks - effectively offshoring this aspect of the tax take. Yikes.

I liked Morgan’s idea this morning on the TV. Reduce tax on income (yay) and set a flat tax on all income (yay) and, apply a flat tax on capital (rubber hits road noises)… Would drive better investment economics, and capture PI debt, farmers, and overseas owners flooding their cash in here. Should allow half the IRD to get fired to due to its simplicity (yay). Who wouldnt want to see part of the Banks recent record profits returned to NZ as tax for roads, schools, and hospitals (double yay).


IMO capital tax should apply immediately for overseas owners as they pay little/no tax and in most cases don’t vote either (low Polly risk). Would be interesting what that would do to property prices as the billions of Property debt would automatically accrue the flat capital tax rate with no offsets. Capital gains would automatically accrue income tax...


Yep, thats what I am curious about, is there a significant enough saving for the individual/entity to warrant handing the cash to the bankers rather than for the clear benefit of NZ citizens. If not, why would you do it? Has anyone looked beyond the sales pitch of those who set this up for you to understand that you are not just holding your ticket out to be clipped with a smile?


there is clearly high polly risk, otherwise the politicians would be sucking that straw for all its worth.   the real risk is that foreign interests aren't prisoners to local authorities like the local people and business are.  Furrieners can just give the finger and take their luverly cash away, leaving the pollies alone in their little sand pit (and no international clout).

remember all property taxes MUST get passed on to consumers.

remember also all wages increases and taxes must be passed on to consumers and spending patterns.

most "capital gains" aren't actually capital gain, they're value stability because the rest of the currency has dropped - the rough way of testing this is to do a valuation.  If the same original asset was worth X,  and the valuation for that same asset today, unimproved, across the market average is X*2,  then you haven't got a capital gain, your economy has just devalued to 50%.   For capital gain compared asset class in Auckland eg 3bd @ 200k 20yrs ago, vs 20 properties across NZ.  Value those 20 properties across NZ again (with some in Ak), that will tell you how much the market has shifted.  Add in inflation over the same time 1 -  3% compounding.   Apply those two scaling factors to the original house to give it's modern economic value.  What is paid above that is capital gain of that property (often due population change and focussed bidders and investment value).

rentier income (dispensible discretionary result of revenue less related expenses) should be taxed at slightly higher than top wage.  Several reasons, (1) it protects the value of labour and real resources as rentier income can be leverage, sale of labour cannot., (2) it attracts capital returns which are direct wealth capture, which can be compounded, unlike labour, see (1).  (3) the rentier streams can (and should) be multiplied creating coupounding wealth effects, doing this quickly will reduce stakeholder value (devalues the rest of the economy, ie productive sources by effectively creating more credit).  Having rentier income should be encouraged, and encouraged more widely, this is best done be ensuring the flat natural born resource (time, labour, skill) has high and holds high value - yet it is important that as many as possible can invest and receive rentier income, and it is better to receive tax/infrastructure from that source (the child return of the child return of the child return of the initial investment is ours to consume). than to destroy the initial income source.   Likewise - over indulgence in consumption of initial labour (ie high wage consumption) is to be discouraged....preferrably by diminishing return and encouraging social gain through private rentier arrangements.

IMO ;)


Indeed - yay. Hopefully the real 'averageman' (and woman) out there will begin to understand the advantages of Morgan's way of thinking.  Must go have a hunt for the TV interview.


Interesting how he more or less states, no I don't pay as much tax as I could if these avoidance mechanisms were not available to me, but the point is, if all the other rich pricks are doing it, well I'd be a fool not to follow suit.


As he pointed out, it's how everyone, aside from those unable to minimise their tax obligations, seem to think/act these days. I also wonder whether trustees might be found derelict in their duty if they failed to similarly take advantage of these tax minimisation schemes in respect of acting in the best interests of the beneficiaries of the trust?


Captain Morgan, he of the "morgan solution" which gets wheeled out every so often, would be more believable if he could first address the "google tax" and overseas "thin capital" problems, otherwise it is just promoting a proposition that is palatable to some, bit like spitting in a tin-lid, rolling it around, and watching it roll around

Presumably, when you say "Capital" you mean net capital or the value of the owners portion of the capital after deducting borrowings, which would be an invitation to all the overseas operators to increase the thin-ness of their capital by increasing their off-shore related party borrowings along the lines of those lower north-island owned power companies


Yeah, that'd work a treat


Thanks for such a comprehensive run down, So the lower tax take as a result of the negative gearing scenario's you have shown is really just collateral damage on a relatively small scale and a mere breath of relief offsetting the added interest cost. That the end result is calculated to overwhelm those amounts by a large margin as leverage (and risk) is increased.