I don't get it. Politicians and economists have been complaining lately that rental property has tax advantages over shares. It's hardly a new claim.
But what are these advantages – beyond depreciation, which is vastly overrated? Let's look at four categories:
Landlords can depreciate the value of the building, deducting a portion of the purchase price each year on their tax returns.
In most cases, however, the building's value grows rather than depreciates. So when the property is sold, all the depreciation is 'clawed back'.
If the seller is in the same tax bracket throughout, she (we'll make her a woman) ends up paying back all the tax breaks received over the years.
True, she's had the use of the money in the meantime. And if she is in a lower tax bracket when she sells – perhaps retired – the clawback won't be as big as her total tax breaks over the years.
But if she's in a higher tax bracket – perhaps because of career advancement or just inflation – the clawback will total more than her tax breaks.
Whatever the situation, the advantages of building depreciation are not nearly as big as is sometimes claimed.
When a landlord (a bloke this time) buys a chattel – either as part of the property purchase or later – he writes off the expense over several years.
Sure, he gets a tax deduction, but only because he spent the money in the first place. And even those in the top tax bracket cut their tax by only 39c for every dollar they spend. Others gain less.
I should note here that some people apparently rip off chattel depreciation, and of course that should be stopped.
But honest landlords pay much more for chattels than the tax break they get.
Landlords write off mortgage interest, insurance, rates, maintenance and so on. But, again, for every dollar they spend, the tax deduction gives them back 39 cents maximum. This is often misunderstood.
A woman told me her rental property investment had reached a bad stage.
After 20 years, her mortgage payments are now mostly principal repayment, with much less tax-deductible interest than earlier.
But that's hardly bad. While her deduction is smaller at tax-return time, more of her payments are going into equity in the house. Every dollar spent on principal repayment is a dollar more of wealth when she sells the house. But every dollar spent on interest costs her 61 cents or more, even after tax. That money is dead and gone.
On any other loan, we would far rather repay principal than interest. Tax deductibility softens the blow on interest, but doesn't change the situation.
The law is complex, but in practice most landlords who don't frequently buy and sell rental properties don't pay tax on their gains. But nor do shareholders who don't frequently buy and sell shares.
It's true many share funds pay tax on their gains, which badly hits the investors' returns.
But index share funds don't pay that tax, and they are generally the best share funds anyway. More on that in my next column in two weeks. In any case, moves are afoot to remove the tax from all share funds.
All in all, then, rental property has only minor tax advantages over shares. To get most of the tax deductions, you have to spend much more than deductions are worth. Doesn't sound like a big winner to me.
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