Tax free capital gain?

Posted June 24th, 2007 by Dr James Pratt

Property investors who use losses from residential investment properties to reduce their taxes are being warned they are likely to face hefty tax bills when they sell their properties.

IRD assurance manager Richard Philp said the money would

"enable us to pursue more investigations and more education in an area we have been actively targeting for some time".

Property investors should take this development seriously, said Jo Doolan, a tax specialist with accountancy firm Ernst & Young.

According to Doolan, if a property investment was structured in such a way that it always makes a loss, the investor would probably have to pay tax on any capital gains when they sell.

Property investments where rental income fails to cover costs such as mortgage interest, insurance and rates, have become increasingly common over the last five years as rising property values have tempted investors into buying a loss-making property in the expectation they will be able to sell it a few years later at a profit.

Doolan said it was common for such investors to sell a property and think they had made a tax-free capital gain, only to be told by Inland Revenue that they have to pay tax of up to 39% on the profit.

"These people are losing real money (while they own a loss-making property) and are relying on making some capital gain, and to then have 39% of that taken from under them, that really hurts."

Doolan said the chances of getting caught in the IRD's net when you sell an investment property are already quite high -particularly if the property is an apartment.

"What IRD tends to do is draw up a list of everyone that bought an apartment in a particular block, and then keep an eye on all the sales in that building."

IRD then looks at how much they bought it for, how long they've owned it and how much they sold it for, she said.

Those records were then matched up with the taxpayer's returns, and if the investor had claimed losses from the investment against other income, there was a good chance the IRD would levy tax on the capital gain.

Doolan was critical of developers and spruikers who promote property at seminars on the basis that investors would be able to make a large tax-free capital gain.

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