Rental property owners have continued to be the focus of all attempts to reduce house prices in Auckland. Some commentators have said we need to make it even harder for investors in order to stop house price rises and give first home buyers a chance.
Tax deductibility of expenses is the latest issue that has been raised. The argument is that because rental property owners can claim a tax deduction we have an advantage over first home buyers. They are calling for our ability to claim mortgage interest as a tax deduction to be banned. So how would this work out?
The fact is, rental property buyers do have a tax advantage over first home buyers, but it isn't highly significant.
The NZPIF conducts a study into the difference between renting and owning the average NZ home. In April the average home was $154pw cheaper to rent than to own, and this was without the home owner making any principle repayments.
After all tax deductions were considered and including a 10% deposit, an investor who bought that average NZ home would have to top it up by nearly $6,000 to provide it to a tenant.
The investor doesn't get the benefit of accommodation from the purchase that a home owner does. This cost means that an investor would be unlikely to pay more than market value for the property and would probably prefer to pay less.
But what about when bidding for a property? If an investor can claim a tax deduction for the mortgage interest, then their cost of borrowing is cheaper, so theoretically they could outbid a first home buyer.
The actual benefit is so small though, that it is unlikely to have an effect. For each extra thousand dollars that an investor bids, the extra interest cost is about $60 per year. The tax deduction at the highest marginal rate is $20 per year. So the actual benefit is quite small. Even if the investor paid $10,000 more than market value, the benefit per year over the home owner would only be $200.
This is not enough to say that the investors’ advantage is a reason why they shouldn't be able to claim the cost of borrowing that is available to every other business or investment.
If the ability to deduct mortgage interest was removed from investors, what would the cost be? Considering the average NZ home example above, the mortgage interest cost at 6.5% is $27,800. At a 33% marginal tax rate, this would add $9,170 to the cost of providing the rental property.
Rather than claiming a tax deduction of around $5,250, the investor would have to pay tax of around $5,500. All this would increase the cost of providing the rental to a tenant from around $6,000 per year to $16,700 per year. An annual cost of $10,700.
As the cost of renting this home is currently $154pw cheaper than owning it, the extra $10,700 cost would surely see a significant rise in rental prices as well as a lack of supply.
Saving for a deposit on your own home has always been difficult. How hard would it be if mortgage interest was no longer tax deductible for rental properties? Would tenants thank those who advocated for such a policy?