Although the Government has ruled out introducing a comprehensive Capital Gains Tax, it still has plenty of weapons in its armoury to battle rampant house price inflation if irrational exuberance once again becomes a hallmark of the residential property market.
Two of its most important tools would be the capital gains taxes we already have, one of which is reasonably comprehensive, although both are known by other names.
Firstly there is the intentions test, under which profits from the sale of a property are taxable, if the property was purchased with the intention of reselling it.
And the family home is not necessarily exempt either.
For example, if someone purchased a home with the intention of doing it up and then reselling it a year or two down the track, any profits from the resale may be taxable, even if they had lived in the house while it was being renovated.
The problem with the intentions test is that it can be difficult to determine if a property was purchased with the intention of reselling it.
One of the things the Inland Revenue Department considers when applying the intentions test is a person’s buying and selling history.
So someone who buys a property and flicks it after a couple of years might escape IRD’s attention. But someone who has done this several times might well find the tax man knocking on their door.
If rampant speculation returned to the housing market, one of the ways the government could combat it would be to tighten the rules around when the intentions test applied.
For example, loss making investment properties, or those that were providing very low rental returns below a specified figure, could automatically be deemed to have been purchased with the intention of making a capital gain on resale, that would then be taxable, because the rental return was so poor.
Such an approach would not be without precedent.
For example the resale of gold bullion and other precious metals is nearly always taxable because they don’t usually provide any income, which means the only way to make money from them is to sell them at a higher price than they were purchased for.
So it would be hard to argue they weren’t purchased with the intention of reselling, unless perhaps you can show that the metal was purchased with the intention of turning it into golden bath taps or door knobs, or to provide new fillings for your teeth and these things had a degree of permanence about them.
The Bright Line Test
The other capital gains tax we already have is the Bright Line Test.
When it was introduced by the previous National-led Government, it made capital gains from the sale of residential properties (apart from the family home) taxable if they were resold within two years of purchase. That time frame was increased to five years by the current Labour-led government.
Another option would be to increase the time limit for the Bright Line Test to 10 years, which would likely capture all transactions within a normal property cycle, and bring it into line with the 10 year time frame used to determine whether profits on properties sold by developers and builders are taxable.
Another tool used to calm the housing market is the loan-to-valuation ratio (LVR) limits imposed by the Reserve Bank on new mortgage lending.
This already has a good deal of flexibility because it allows the Reserve Bank to adjust mortgage lending limits for different classes of property buyers, such as allowing a higher LVR lending limit for first home buyers while restricting high LVR lending to investors.
And the Reserve Bank has already demonstrated its willingness to adjust LVR limits according to changing market conditions.
However the Government could also consider adding debt-to-income ratio restrictions to the Reserve Bank’s toolkit, which would give it even more flexibility if it felt the need to rein in excessive mortgage borrowing/lending if property prices started tracking up sharply again.
In the period when the Government was considering whether or not to introduce a new Capital Gains Tax, its opponents were vociferously proclaiming the detrimental effect CGT would have on the property market.
Now that a CGT has been emphatically ruled out, it will be interesting to see if this sparks an upturn in property market activity and a corresponding lift in prices.
If it doesn’t, that suggests that the detrimental effects CGT could have had on the property market were probably being overstated by its opponents.
But if the housing market does spike sharply upwards again for whatever reason, there’s plenty the Government and the Reserve Bank can do within the current tax and regulatory framework to cool things down, even though CGT has been consigned to the rubbish bin.
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