Jenée Tibshraeny investigates whether people trying to avoid paying tax on capital gains from property sales are being caught

With the Auckland housing market red hot, pressure is mounting on the Inland Revenue Department (IRD) to pursue quick flick merchants who may be pocketing substantial capital gains.

The Reserve Bank of New Zealand (RBNZ) has not-so-subtly called for the Government to reconsider potential policy measures to address the tax-favoured status of housing investment. In his eye-catching speech RBNZ deputy governor, Grant Spencer, steered clear of specifically suggesting a Capital Gains Tax (CGT).

And Prime Minister John "what-housing-crisis" Key continues to rule out a CGT.

Meanwhile, Finance Minister Bill English says the Government will be enforcing existing law, which requires people who trade in houses to pay a tax on their capital gains.

English says; “If investors are buying up houses with a view to flicking them on, then they will have to pay tax on that… and that’s why it’s important that IRD enforce that comprehensively.”

How hard is the taxman cracking the whip?

This begs the question, how is the IRD interpreting and enforcing the Income Tax Act? Are those trying to avoid paying tax on their capital gains being caught?

To clarify, existing legislation means that if Person A tells the IRD they’re buying a house with the intention of selling it off after a few years for a profit, they have to pay a tax on the profit they make.

But if Person B declares they’re buying a house with the intention of earning revenue from rent, then has a marriage break up, sells the house and makes a profit, they don’t have to pay tax.

Go figure!

This is where the IRD faces the mammoth task of differentiating between people who buy houses to put a roof over their head, and those who buy houses purely to make money. 

IRD says it has snapped an overseas-based tax-evader, who tried to argue they sold their property because, “I found out I could not speak English and therefore could not come to New Zealand”.

The IRD’s recovered tax from another swindler who said, “I sold it because it was a two-storey home and my wife didn’t like the stairs.” Investigations found the person purchased another two-storey house with stairs a few months later.

Another excuse the IRD’s seen through is; “I sold it because it was only two bedrooms and was not suitable for a family of four.” As it turned out, the trader (who apparently didn’t know they had a family of four) bought and sold 18 two-bedroom houses in three years.

It says people who buy properties to renovate and sell are sometimes also unaware the profits made from such sales are generally taxable.

$56.6m recovered

The IRD has recovered $56.6 million in tax discrepancies since July 1 last year. It identified $52.4 million of discrepancies in the year to June 30 2014.

A spokesperson says; “The annual target has been $45 million each year for the four years of Budget 2010 funding, and has been continued as a target for the 2015 year. We are currently on track to exceed this amount.”

Is this enough?

Let’s say for example the average amount of capital gain sellers are making is $150,000 on a property, then assuming a 33% tax rate, the IRD would need to identify discrepancies from around 1,150 properties, to recover $56.6 million of unpaid tax.

Given Barfoot & Thompson sold $1.24 billion of houses in March alone, a tax specialist is surprised the IRD isn’t picking up more discrepancies.

The head of Baucher Consulting, Terry Baucher, believes there’s scope for it to identify more unpaid tax, especially as IRD usually recovers between $5 and $6 in additional tax for every dollar spent on investigations.

The IRD says it monitors more than 28,000 individual titles and checks the returns when properties are sold.

Its 2014 Annual Report says IRD has concentrated on identifying developer speculation, particularly in Auckland and Queenstown.

Baucher says it has been specifically targeting areas around South Auckland and Botany.

As for the people doing the job, the IRD hires 52 mainly field investigators, to work in its Property Compliance Programme.  

A spokesperson says; “There was a slight increase in staff resources in 2010. This was in response to Budget 2010 allocations (effective 2011) ensuring staff were available to undertake investigative work from 1 July 2010. Staffing numbers have been relatively static since then.”

Baucher says; “You just don’t know what [political] pressure’s being applied and what’s being discussed behind the scenes.”

He says IRD staff will undoubtedly be reading the signs from the Government to promote tax laws that can help cool the property market.

“Then you would expect IRD would also turn that around and request additional funding… I would expect that at the very least there will be additional resources given to the IRD in next month’s Budget to pursue this.”

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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49 Comments

Most are successfully avoiding tax speculation with a law that is too clumsy to to be effective. As in the examples above. IRD is on the back foot in dealing with this one.

i wonder if Jenee has a though on the taxable nature of the following.
An investor buys a property the following year he buys a second property using the capital gain from the first property to fund the deposit on the second.
This process is happening every day in Auckland. Vast portfolios are being established.
My contention is that the IRD should see the money for the second deposit as a taxable event

Exactly - good point. It would be nice to have that proposition put to the IRD for a response. It happens every day not only in Auckland but all over the nation.

Recently been involved in house hunting for a son in P North and the numbers of properties who got QV to do re-valuations mid-term as a result of improvements (many revaluations which I would add were just over-the-top) was astounding .. perhaps 40-50% of all the properties on the market.

That's because PNCC rates are based only on land value and not value of improvements so it makes sense to update value after improvements where this is the case ( a lot of other councils I believe work of cap value which includes improvements, so updating GV means a bigger rates bill in auck for e.g). Does make the market appear slightly flatter than it actually is though as QV see houses selling for around GV (after GV has been boosted 10% by a sometimes generous revaluation), whereas if no revaluation was done the indexes would be up more as more property would be selling above GV.

Sounds pretty clearly non taxable to me. The investor still owns and is renting out the first property which suggests their motivation is to achieve a rental return. The fact they have been able to leverage the first property to fund a second maybe even provides some evidence of the viability of their business model.

Might be a different story if they sold the first property to fund the first I guess...

If I buy a coupon paying bond below par, the IRD demands the annual calculated pro-rata capital accrual towards par at redemption, irrespective of a sale or not, be added to the yearly interest tax band demand.

Exactly.

errmmm yes. Of couse they do (and should).

Buying a rental property is completely different. In your example you KNOW what the coupon value is/will be but the value of the house could go up or down or nowhere (particularly in Auckland at the moment).

So completely different scenarios = completely different tax treatment.

How does the property owner get access to the capital gain?

How do you know the capital gain is real?

Eventually something will be done, but not before

One day, when someone exploits and abuses it in such flamboyant style and embroils (or hurts, or takes down) a number of prominent people in the process, then something will be done, maybe

The situation we have today is not new, it has been bubbling away for sometime, but, as always, time moves on, and in this new paradigm of 24/7 rolling news, what was newsworthy yesterday is forgotten tomorrow. It's the nature of the beast.

While we slumber away in our cocoons, here's the next episode of this drama

Imagine there are $ billions of overseas money invested in Auckland property that has been built up over the past 7 years, and then one day in the future there is a global event that causes the continued investment in that property to be dis-advantageous here, but more advantageous elsewhere, and the hidden investors either liquidate their holdings, (a bit slow to do) or extract their equity via 90% bank loans and transfer the money overseas the very next day, then sell the property and remove the remainder of equity overseas the day of settlement.

All well and good so far

But, the money is gone

Try and get the tax on the profits out of them afterwards.

If the taxman thinks he's going to get that money he's dreaming

Thanks for coming

IRD and government are looking for an excuse to enlarge the affected area - not just go after the "for profit" trades but to find away to capture more of everyones money.

However currently the existing system suits their investor masters happy at the moment.

We seem to be a bit confused over these issues. As we are frequently told the Auckland housing mess is primarily caused by artificially constrained land supply, a building material supply cartel, unprecedented net immigration and a world awash with cash looking for investments. Certainly our tax system encourages property investment because capital gains are not taxed, either legally or practically.
However introducing a CGT is unlikely to make a large dint in the present frenzy, may be long term. What we need is government action to meaningfully address the problems as opposed to the present lot who are really only window dressing because the present situation suites their supporters.

A CGT is required as part of a balanced tax system that ensures that all sectors of the economy are on a level playing field and we do not get distorted investment decisions and behaviours at the expense of the wider and productive economy.

Because the money can move in and out so fast, the tax has to be on the front-end going in and not the back-end coming out - ie - stamp duty or sales tax

The ownership of all properties are recorded. It is just a matter of automatically interrogating the relevant files and lining them up against the tax returns.

Of course the means of interrogating the files and assessing tax-payable is the easy part, but how do you collect it if the money and the taxpayer have both disappeared overseas

Bit like student loans isn't it. A debt is created and interest accrues.
1 They will never get to come back to NZ
2 The world is becoming increasingly connected at a rapid rate, and nations are starting to work together to deal with tax dodgers. At some time down the track they are in for a nasty surprise.

PS spell check on the site is great. Thanks guys and gals.

Actually that part is the easiest and best part. Same as rates failure, the amount accrues until a certain point, then if no notice/contact is available the place is considered derelict and the property is sold to recover the outstanding debt. Of course a trust would have to record any excess, and be held in reasonable escrow (eg through Public trust Office), for a certain number of years.

If the place is let, then the letting agent will have somewhere to send the rent money and to seek permission regarding property issues. Otherwise where would the rental money be going? ... and if no rent, then who is the occupier (and by what contract?) How are the rates being paid?
If no rent and no rates, then it _is_ derelict. If no rent and rates being paid but occupier has no contract then they are squatting !! (and thus the property is derelict).

Many investors are aware and don't care of the requirement to pay tax on profits made if the house was bought for the intention of resale (the IRD would classify these people as being on revenue account and thus taxable vs capital account). It's like filesharing from New Zealand, or antelope crossing a river in Africa - the sheer weight of property tax avoiders hugely outnumbers tax inspectors and the reality is they probably won't get caught.

Let's put some numbers behind this.

RBNZ C31 which shows mortgage lending by borrower type shows at that 30% of all mortgages are from property investors. Only about 66% of houses purchased require a mortgage, but lets assume 30% of all wholly equity financed house sales were likewise bought by investors. Therefore - 30% of every house bought or sold is by an investor.

In the last 12 months to March 2015 a staggering $40.979 billion dollars and 76,920 houses were sold - for an average price (averages not medians are relevant for calc. tax) of $532,746

The 12 months to March 14 had $38.670 billion and 78,557 house sold for an average $492,255

Lets assume 30% of houses were sold by investors = 23,076 houses
(x) Average capital gain per house of $40,491
= which equals $934 million of what should be considered taxable income
(x) say marginal tax rate of (say) 33% = $308 million of tax revenue to the IRD

But yet they only collect $54m? That's only 17.5% - or 17.5 out of every 100 property investors selling with a capital gain. That's 83% of investors who should be paying tax that don't.

The numbers are too large and we will never be able to staff the IRD appropriately to force investors to pay tax if they operate on revenue account and likewise the odds are so stacked in investors favour that they will never be convinced to pay their tax full and in fair.

Therefore - the only way around this issue is a mandatory across the board capital gains tax on non primary homes. It's not the sole solution - but its one of them.

The problem really seems to be that while they know they should tax property gain income, those who are in a position of power would really rather look the other way, and that includes both left and right wing legislators, because it is so much part of the NZ tradition. In all probability they are all at it, and so are their mates, and similarly national party supporters. Pure selfish and vested interests, never mind the fact that it is stuffing the wider economy and further impoverishing the vulnerable.
On the other hand if you tried the same thing with investment in the income producing nuts and bolts of a productive company that contributed to the economy, the tax department would be down on you like a ton of bricks. They seem very willing and able to do that.

The problem really seems to be that while they know they should tax property gain income, those who are in a position of power would really rather look the other way, and that includes both left and right wing legislators, because it is so much part of the NZ tradition.

Hmmm - In my time at Federated Farmers I have heard a lot of politicians say they will tax farmers more heavily.
The latest was David Cunliffe, and he was straight up about it at our national conference, where he said he would tax farmers more on water, capital gains and general tax. The reaction from the general public and voters from the regions was a resounding no. Taxing one group more than the other in New Zealand politics has never worked out well for politicians.

So I can only ask why the Waipa District Council is looking to try the same. In the past they have been a great council to work with and Federated Farmers Waikato has even promoted them as the benchmark amongst all councils in New Zealand for fairness.
So why have they done a 180 degree turn on their current Long Term Plan?
The Waipa District Council have decided to change their rating mix and increase rates disproportionately from the rural sector of the community.
Read more

"Taxing one group more than the other in New Zealand politics has never worked out well for politicians."

It's worked very well for John Key. Lowering taxes for the wealthy (top tax rate drop) while raising taxes for the poor (GST increase).

Cuntliffe going for the Hate Vote again.

Why tax farmers for such things?
Water isn't owned by anyone - so government trying to tax it is called theft.

Capital gains - Like some houses it's the store of value, not an actual gain, and why would it be taxed? Is he trying to slow or prevent farm improvement or prevent interest in farming?

General tax? OMG what ! Reminds me of the religious tax the medieval Islamics nation used to do to the Christians in their country.

Why would Cuntliffe want to take MORE money out of farming, it's already horrendously low revenue for its setup cost, and brings huge export revenues into NZ. What needs to be done for farming is to reduce the burdens, tax of otherwise, and give the distribution chains that undersell the product a kick up the arse so they can give respectable yields to the farming operation...then that will increase the economy and develop farms to more effective businesses..... not tax them into less effectiveness.

National : the party for the large corporations
Labour : the party for the workers enslaved to the large corporations.

Water not owned by anyone - most especially not foreign bottled water corporations, they can take the stuff for nothing - so something needs to be done about that in a world where water resources will become more and more precious.

(1) Entrench in law that water falling on a person, dwelling or corporate property is that persons natural non-transferrable and non-taxable property, Thus they have first option to grab or release it.

(2) Run off and storage must not become public nuisance or safety hazard. (ie no stagnant ponds or unfenced "swimming pools".

(3) uncaught water is considered a natural resource. To be _protected_ but not owned by the State (including protecting peoples access, cultural rights, fishing and eeling and vegetation rights)

(4) All management to be transparent and cost effective.

(5) Information on water flows and expect surplus to be publicly available, and conditional allocations of surplus to be made available. No guarantee of surplus, and on a pro-rata availability.

Surely National and Labour are just the plantation managers for the banking sector. They are given a certain freedom of action as long as they don't rock the boat. The interest on the household debt must be paid.

Precisely RW and you can add the RBNZ to your list with the pollies ; real estate agents and fontera with the banksters. They, the rbnz, will do anything they can get away with to succour them at the expense of savers and consumers, who end up earning less interest, paying a higher cost of living through more expensive imports and more for price inflated houses with bigger and bigger mortgages.

Productive economy?

What do you call shelter and a place to live if not a human NEED.
And if it directly services an actual Need (not just consumerist wants) how is it not productive?

A house is a house. Once built is just sits there and is either owned or rented. It does not produce anything or earn any much needed export dollars.

... you could convert some of the rooms into a small business opportunity ...

P-Labs seem to be a growth industry in NZ ... or set up an internet boiler room and try to scam rich Nigerians out of their savings .... re-process hair from local salons into pony-tails , and sell them to the Prime Minister ...

A house produces shelter.

"export" dollars are far overrated and poorly comprehended by economics and finance people. to those people "export dollars" are mystical mana from heaven; they are the free energy into the closed system.

you cannot design your system around everyone receiving "export dollars". Because it would require some of those "mystic dollars" to come from outside the system.

And even in NZ's case, even when some mystic export dollars do show on the horizon then RBNZ puts up the interest rate to penalise any recent market entrants and remove the advantage from their business.

But a house... it doesn't just sit there. Shelter is the sizzle, the consumable. The location is the value add, the premium. Please note for example, your comment is entirely wrong because all rented houses are owned by someone.

So how does someone get their equity out of such an asset? How does one disposal of the "plant", the secondhand fixed asset? by sales to others. Just like my friends mixing desk - he got it second hand, cheap. when he went to upgrade, he got offered more for his old one than when it was originally purchased new. Turns out that it was a top quality model, one that was hard to find. Thus the market had moved it up in value. He had not improved or value-added to it, so the store of value meant he owed no tax on it. Sadly however, his new mix desk had already moved much further up in the market too (and was worse quality)...if he didn't need the extra channels....

!!!!!!!!!!!!!!!!!!!! How do you stop the illegal double taxation from the measure you are proposing?

When a property acts as a store of value, it is the devaluation which appears to make it go up in value. The US uses the 401(k) technique to stop double taxation.

It would be nice to say only improved properties truly have capital gain ... but do you really want to discourage (tax) people from improving the housing stock and peoples' living conditions? (from the few who actual make improvements?)

Also a very important factor is that in many cases the total numerical gain is very low, in the order of 1 - 3% per annum ! And in most of New Zealand for the last 8 years has actually been a loss !!!!

So once again your talking about penalising ALL the rest of New Zealand, especially those new entrants to property ownership. for the Auckland problem.

and the real source of the problem is wealthy foreign investors, in _Auckland_, who aren't going to be affected by your measures.

If you are going to "solve" a problem doesn't it make sense to actually work out if their is a problem in the first place.

And said it before, have to say it again, WTF! is it with you idjits that just want to f..in' tax everything and anything to death. Is that what your ANZAC died for? Is that why their ancestors came to NZ? to find the most comprehesive tax system they could develop? or is that the kind of stupidity they were seeking freedom from?

Only problem with that logic, is the $54 Million is the additional amount is assessed as a result of audit work carried out from people who had otherwise not paid the tax, I assume there are at least some people who pay the tax without needing to be caught.

It's recovered tax, very good, but what were the penalties recovered?

The government is full of property investors, why are we so surprized they are happy to screw the country to line their own pockets

Save all your breaths... property investors are untouchable. Haven't you learnt that yet?

I can't tell if you're being a satirist, or one of the dark triad (narcissism, Machiavellianism and psychopathy)

http://www.ird.govt.nz/property/property-common-mistakes/mistake-dealing...

Anyone buying in auckland neg geared, making loses, then selling for a profit may be liable to pay capital gains tax on profit from sale. I can see a very good argument the IRD could use to make this happen no matter what BS story the speculator comes up with; you don't buy 4% yielding property, then make actual and verified losses over a number of years if you're intention was any other than the cap gain on a future resale

Ah if only it was that simple, unfortunately judges have tended to believe the BS and logic rarely comes into it. Seems everyone except judges and accountants acting for the speculators knows you don't buy low rental yielding Auckland property for the rent unless your in it for the long haul.

I don't know why the net couldn't be widened simply by applying the current law but using a new practice of assessing the tax filings associated with any property owned but not lived in the owner. Simple test:

Over the years owned, has it paid net $ to IRD? A lot of neg geared auck property held for up to 10 years would still be a net receiver of $ from IRD. Is so, simple, cap gains tax applies due to the assumed intention of owner (despite any story the owner comes up with).

Any exceptional circumstances can be considered, but as a base rule, this simple practice alone would widen the cap gains net considerably.

Still can tax net payers to IRD if they met the other criteria of speculator/flicker eg by working with builders and displaying patterns of behavior.

Pursuing a capital gains tax on residential property would be trying to penalise the innocent. If the IRD were serious about fixing gaping loopholes, they would remove tax deductibility of interest costs on all residential property, enabling them to actually collect on the the tax liabilities people have incurred elsewhere, and which the IRD have already spent tax payers dollars and resources identifying and recording. If the government really wanted to make owning residential property affordable, so that far fewer people needed to rely on landlords for a disproportionate share of the supply of housing stock, that would be the smart move. As long as banks set government policy for their own benefit, it won't happen, I'd expect house price declines of 70% or more if it did. There is no shortage of housing, just a shortage of affordable housing, which can be solved by a nice price crash. If I were a student revolutionary and wasn't too busy making a crust, thats the thing I'd be smashing windows about, after all, its the young who are having their futures drained by the world's vampire squids.

interest costs are legitimate business expenses though, difficult to make a law that singles out property.

Cap gains law where intention for resale at any time later for profit means tax is due is an existing law already, just needs to be applied better.
Trademe sale would possibly fall under this cap gains too if they always had as an exit strategy to sell for a huge profit once customer based built up. But Id imagine that sale was incidental as TM was making big profits by that stage so can stand a lone as an income generating business

Hi Simon, no I think its really very easy to do. We have gotten used to housing being treated as just another business, its become normalized in the national perception, but the situation is far from normal if you look back further... residential property has mutated out of all recognition of its original purpose, i.e. to keep the rain and cold out, and to store your stuff in. I was involved in real estate in the UK in the 1980s, and at the time there was a massive tax loophole called Mortgage interest relief at source (MIRAS). Married couples could both claim interest costs on their mortgages against their income tax; a tax law which was eventually repealed. On the Friday before the law changed real estate agents in the office I was at were as busy as they had ever been, on the Monday after, the phone only rang once, from another branch of the same company, to see if the phone had been cut off. No-one continued to ring real estate agents for at least a year afterwards, which improved affordability for home buyers massively. The crazy market stopped dead in its tracks, by removing a perverse incentive. Housing is not just another business, and should stop being treated as such, these are peoples homes, and the risks being taken now are putting our economy in jeopardy, and individual households financial and physical security at risk.

snippet of vital info quietly slipped out of the murk at the tail end of the business news last night

In Australia (nationally) there are

9 million residential homes, of which
1.9 million are investment properties, of which
1.2 million are negatively geared

21% of all properties are investment properties

63% are negatively geared

Of the 1.9 million investment properties

93% are/were existing properties
7% were new
meaning property investors don't build new, don't add to housing stock

Compare
40% of all Auckland properties are investment (rental) properties

There is a simple fix and I'll explain it again. Remove the capital/revenue distinction from all tax law. If it's income, tax it.

Think about, it makes sense that tax law was initially influenced by the capitalists because they didn't want to pay tax.

Even the Auckland Property Investors Association is now calling for action.
See NZ Herald today

Thanks for the reference BB3. Would a cynical view be that even local investors are now being outbid more often than not?

I cannot find the article you mention in today's Herald?? Too often in the media, and amongst popular opinion, the term property investor is confused with property speculator. A speculator buys with the intention of selling. An investor holds for the longterm and the primary purpose of the investment is to generate income (ie,rent). There IS a Capital Gains Tax in NZ, on property spectulators. The government (IRD) has recently put more resources into enforcing the CGT but still more resources need to go into this. Also now investors are unable to claim depreciation on their investment property (unlike in Australia where they still can), and when this was introduced in NZ a couple of years ago, rents went up after this as a direct result. I am a property investor who bought 2 residential investments over 20 years ago,taking the initiative to provide for my retirement, and have laboriously paid off the mortgages on them, having seen property cycles come and go over this time, and paying tax on my rental income. Ongoing maintenance takes a very large part of the rental income, as does rates and insurance. I would imagine there must be many other mum and dad investors like myself, flagellated scourge on society that we are!

Patience. This isn't over. Not yet. Some distance to go.

The drum beats are getting louder.

Local investors have been getting skinned for some time without realising it

The sad reality is that subdivision is far beyond the common man. You need to a lawyer, planner and accountant all at the same time. Auckland is at the mercy of development companies who buy up land that the common man cannot subdivide.