Investing in rental property has long been a favourite form of retirement saving for many ordinary New Zealander’s, especially in lieu of a comprehensive Government-funded superannuation scheme.
It’s not hard to see the appeal; even if a rental property is initially bought with a large mortgage – leaving little (if any) rent left over to provide income – by retirement age, the mortgage repayments should have reduced significantly, while the rental payments and the value of the property are likely to have risen considerably. The investor then not only has a good income stream from the rent, but also ends up sitting on a property asset worth considerably more than they paid for it. They can then either sell the property and make a substantial gain, or continue to use the rental income to supplement their pension. So, is property investment right for you? In order to decide it’s important to be clear about exactly what is involved.
Investor or developer?
There are essentially two types of property investment; buying a house with the intention of renting it out for more than your outgoings, or buying a property in order to improve it and sell it on for profit. The first type of investor is a rental investor, the second type is a developer. The distinction is important. Any gains a developer makes from the sale of property is taxable, whereas if, over time, your principal income is from rental payments, then no tax will be payable when you sell the property, even if you have made a substantial gain. It’s all about intent. If your purpose in buying a property is to resell it, then the profit you make when selling it will be counted as income and taxed accordingly.
When we think of developers we visualise hard-nosed wheeler-dealer types buying houses cheaply, then swooping in with a gang of tradespeople for a quick renovation and sale, before moving on to their next project. However, not all developers are Range Rover driving businessmen in hard-hats. Many ordinary people go about this type of activity quietly and on a small scale; buying a house and living in it for a couple of years while renovating and making improvements then selling it at some point in the future for a higher price than it cost to buy and do-up. It’s a way of being able to steadily trade up to a bigger home or a better neighbourhood. Surely their gain isn’t taxable? Well it’s still a question of intent. While there is an exclusion from taxing the sale of properties that a taxpayer occupies mainly as a residence, that exclusion will not apply if you have a regular pattern of acquiring and disposing of residential properties. Of course the reason property investment appeals to most people is because of the potential for high capital appreciation, especially during booms. If you are considering investing in residential property as a method of generating short, or even medium-term gains, be prepared for the tax man to be sharing in your speculation profits. Hence the popularity of becoming a landlord…
This is an extract from The Streetwise Home Buyer. The full chapter covers much more and you can download it below for free.
- Landlords and tenants
- Rental yields
- When losses are a good thing
- Buying the right property