GST Traps for Property Investors
When talking tax, most property investors immediately think income tax, principally because residential renting remains an exempt activity for GST. But there are situations where residential investors face GST traps and often find themselves ill equipped to see them coming.
In this article we shine a light on some of the common situation to watch out for.
Airbnb Short-term Letting
Whilst the provision of residential accommodation in a dwelling is GST exempt, the letting of a property for short term holiday stays is a taxable activity for GST. GST registration is not compulsory provided the taxable supplies fall below $60,000 which often means registration is an elective choice for those providing short-term accommodation. Whilst claiming GST on a property acquisition may seem like a great option, this of course means that the subsequent on sale of the property will be subject to GST which could be substantially higher than the amount claimed if the property has appreciated.
The rents charged to guests will also be subject to GST which in most cases is a cost the owner will need to absorb rather than charge on to guests.
Be aware that if you intend claiming GST on a property this is a material factor with respect to finance, as the obligation to pay GST on the sale trumps even the mortgagees rights to recover lending, so it is a material disclosure point to a lender who will almost certainly require any GST refund to be applied against the mortgage.
When considering the compulsory GST registration threshold, realise that the $60,000 is entity specific not property specific. So, if the sum of all taxable supplies exceeds $60,000 registration becomes compulsory.
Consider this example;
John has owned a bach on Waiheke for twenty years in his trust. He earns about $50,000 from renting it night by night to holiday makers. In the twenty years of ownership, it has increased in value by more than $1,000,000. John’s trust is not GST registered because the income from the bach is under $60,000. John now decides to buy a commercial carpark as an investment which earns $15,000 per year and opts to put this in trust as well. John opts to keep the trust unregistered because the rent from the carpark is also under $15,000. When John’s accountant does his books, he delivers John the bad news that because the aggregate rent from the bach and the carpark is over $60,000 the trust is forced to GST register. John can only recover GST on the Cost of the bach but has to now accept that when he sells it, GST will apply to the full sale price including the $1,000,000 capital gain he has had over twenty years. Ouch!
Second-hand Good Claims
With much residential land being rezoned for higher density housing many investors are considering developments of long held investment properties. Developments for resale are taxable and subject to GST. When the use of a property is changed to development it is often suggested that the land be restructured into development companies to protect existing capital gains and isolate commercial risks. There is a GST downside though. When introducing land from an unregistered person to a registered person there is generally the opportunity to claim a 15% second-hand good credit on the purchase, but this opportunity exists only where the land is acquired from an arm’s length person. Where the land is acquired from an associated party the GST claim is limited to the GST originally paid, which is usually zero.
Compulsory Zero Rating
All land transactions in New Zealand are subject to compulsory zero rating of GST when three criteria are met:
Where both parties are registered
Where the purchaser undertakes to use the land in a taxable activity
Where the purchaser undertakes that the land will not be their principal place of residence
So, if you are a new property developer and are negotiating a contract that is “inclusive of GST “ be wary, if the conditions for compulsory zero rating are met, the GST is included at the rate of zero, not 15%. No refund is therefore available as it might have been if the vendor was unregistered. If you don’t know the vendors GST status, you are not ready to make an offer!
Change of Use Adjustments
If an investor changes the use of a property from exempt to taxable, by perhaps doing a commercial alteration or embarking on a property development the GST claim is no longer able to be made in a lump sum on the change of use. Instead, the claim must be made in the March adjustment period in the proportion of the time the property has been in the taxable activity verses the exempt activity. The claim is then washed up with a subsequent payment in the adjustment period at the end of year two, or in the period where the property is sold whichever is the earlier. This delay in making the input tax claim can have a significant cashflow impact.
Changing from Commercial to Residential
If a building is converted from a GST taxable commercial use into a GST exempt residential use this change in use triggers the requirement to account for GST. If the entities GST taxable activity is finished as a result of this GST is payable on the market value of the property. If however the entity has an ongoing alternative taxable activity that enables it to remain registered, GST is payable on the cost of the property rather than its market value.
As always, seek professional tax advice before undertaking land transactions.
