Depreciation may need looking at: Commission

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The government might need to take another look at its removal of depreciation for investment properties, says the Productivity Commission.

Monday, December 19th 2011, 12:00AM 1 Comment

by Rob Hosking

The commission - formed last year as part of the National Party's support agreement with the ACT Party - released its first report, on housing affordability, this morning.

The 228-page report - which is only a draft - covers a wide range of topics affecting the housing sector.

Although broadly supportive of the changes the government has already made in the tax area, the commission says the removal of depreciation needs to be monitored.

Removal of depreciation "appears to have been based on an assessment that for buildings, ‘capital gains' which are not assessable, and outlays on repairs and maintenance, which are deductible, offset physical depreciation," the report says.

"From this perspective, the recent elimination of depreciation deductions for buildings can be seen as a ‘pragmatic' way to cut through a situation involving a number of moving parts - capital gains, inflation, rates of physical decay, and repairs and maintenance outlays.

"That suggests a need for something of a watching brief to check, going forward, whether those moving parts continue to more or less balance out."

If house prices fall in real terms over the next decade, the report says, then more "tweaking" might be repaired, the report says.

"Being unable to claim neither depreciation nor capital losses could result in insufficient recognition of the economic losses of providing rental accommodation, and hence create a huge disincentive to invest in it - just as the combination of depreciation deductions and tax free capital gains drew investment into the sector."

The commission is not in favour of a capital gains tax, on broadly similar reason to those which led the Tax Working Group, two years ago, to rule out such a tax.

That is, the commission accepts there is a case for widening the tax base by including capital gains on housing, but notes that this case falls to the ground if owner-occupied housing is exempt, and if it is imposed only when a property is sold and not on an annual, accrual basis.

The report also advises strongly against "ring fencing" rental losses, saying it would only create a new set of distortions.

The commission also says the "tax advantage" enjoyed by investment in housing has been over-stated. While accepting there is some advantage, the commission says that most of the tax advantage applies to owner-occupied housing.

The only area the commission sees some significant tax advantage for landlords is the ability to claim full deduction for interest costs.

"While a combination of house price inflation expectations, and relative ease in arranging debt too finance residential rental investments, will have been the main driver of the upsurge in investor appetite for leveraged rental investments during the recent housing boom, full deductibility of the interest expense will have been an added factor."

Rob Hosking is a Wellington-based freelance writer specialising in political, economic and IT related issues.

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