Kiwi Saver, Mary Holm financial writer and columnist

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Weekend Herald

Mary’s Q&A column appears in the Business section of the Weekend Herald. Mary was a finalist for the "Best Columnist – General" award for this column in the 2014 Canon Media Awards.

NZ Herald March 25 2006

Q&As: Stick with share fund investments.
Is it wise to depreciate if you're selling your rental quite soon?
Tax treatment of the expenses of rebuilding leaky rental property.

Question: I am writing regarding last week's letter from the person who invested a lump sum in Tower Tortis International in 2000 and recently withdrew his money at a substantial loss.

I started investing in that fund in October 2001 with $100 fortnightly for two years. I then increased it to $200 fortnightly.

In 2001 the value of the fund was already dropping. I thought, what the heck, I will be in the fund for at least ten years. As you know, the NZ dollar kept appreciating while international share markets meandered along for a while. The fund kept getting lower, losing almost 40 per cent of its value, but I kept investing regularly.

As we know what goes down must also come up. In the last 1.5 years, there has been quite a remarkable upturn in the fund.

Even though it is still about 10 to 15 per cent off the original amount of the fund when I first started, I have had almost 4 per cent per annum return, after tax and fees, of the total amount currently invested in fund. This may sound paltry, as I do not know how to work out annual returns based on the regular investments that I am making!

That just adds weight to what you have been saying in the past, that dollar cost averaging and time in the market rather than timing the market are the important aspects of investment.

Answer: Good on you. You, of course, had the advantage of drip feeding into the fund as opposed to investing the whole lot at once - which always makes it easier to cope with downturns.

That's when dollar cost averaging comes into its own. If you invest the same amount regularly into a share fund, regardless of market movements, you end up buying more units when the price is low and fewer when it is high. Your average price will be lower than the market's average price.

That doesn't mean, though, that if you had a lump sum you should necessarily drip feed it into a share fund. Presumably you would hold the un-invested money in a bank, where on average it would earn a lower return.

Those with lump sums are probably best to put the lot in right away, or perhaps in two or three chunks over a few months.

Whichever way you invest, though, the message that you shouldn't bail out because the market falls still applies.

Your difficulty in calculating a return on a drip-fed investment is fair enough. It's complicated. Your best bet is to use the regular saving calculator on the Retirement Commission's www.sorted.org.nz

The calculator asks you to enter a return, which you don't know. But just guess a number and see if that brings your total close to what you have actually accumulated. If not, adjust the return until it does.

In your case, you would have to work out separate returns for your $100 and $200 periods. The calculator can't cope with varying amounts.

One more point: What goes down won't always come up if you have invested in just one share, property or bond. But if you are in a fund that holds many investments, such as Tortis International, you can be confident the value of the fund will always rise again.

Question: I have recently rented out my house that I own and moved in to my partner's place, which he owns. My house has been rented out for approximately eight months, so I am approaching my first tax return.

I bought the house in 2003 for $200,000, and it is now worth approximately $300,000. I will probably sell the house in about 5 or so years so that my partner and I can build.

Should I start depreciating the house when I send in my first tax return, or is it not worth doing as I may sell the house in the next 5 years?

Answer: You should certainly depreciate the chattels in the house. They will probably lose value at about the pace of the depreciation, so those deductions won't be "clawed back" when you sell the house.

On the building, things aren't as clear cut. Let's work through an example.

You would start your depreciation from the building's value when you bought it, even though you didn't start renting it out straight away. To keep things simple, let's assume the building was worth $100,000 then, with the other $100,000 made up of land - which cannot be depreciated - and chattels.

Typically, you would depreciate the building at 4 per cent, or $4000, a year. That deduction would reduce your taxable income by $4000. So, in the 33 per cent tax bracket (taxable income of $38,000 to $60,000), you would pay $1320 less tax each year.

We'll assume you are disciplined, and put that $1320 a year into a savings account, which earns 7 per cent interest, or 4.69 per cent after tax.

Turning again to the regular saving calculator on www.sorted.org.nz, we find that over five years the account would grow to just under $7250, after tax.

At that point, you sell the house at a profit. Under the depreciation clawback rules you would add five $4000 deductions, totalling $20,000, to your taxable income that year. That's because you've claimed depreciation that didn't happen.

At 33 per cent, you would pay $6600 tax on the $20,000. Take that out of your savings account, and you are left $650 better off - your accumulated interest on the money. Not a bad bonus.

What would happen, though, if you moved up to the 39 per cent tax bracket (taxable income of more than $60,000) that year? That's quite likely if you are adding $20,000 to your income.

Part or all of the $20,000 would be taxed at 39 per cent - depending on how much your income exceeds $60,000.

If half was taxed at 39 per cent and half at 33 per cent, the tax would total $7200, almost wiping out your $7250 of savings. In the worst case scenario, if the whole $20,000 was taxed at 39 per cent, you would need to come up with $550 from elsewhere.

There are all sorts of variations on this:

* If you are already in the top 39 per cent tax bracket, moving up a bracket is not a worry.

* If you have retired or are working only part-time when the clawback happens, you may be in a lower tax bracket. Let's say you drop to the 21 per cent bracket, even after including the $20,000 of clawback income. You would pay only $4200 tax on the $20,000. With bank savings of $7250, you would be ahead by more than $3000.

* And if, perish the thought, you have to sell the property at a loss, the depreciation clawback would be smaller or even non-existent, depending on your sale price. You would be glad you at least got the benefit of claiming depreciation over the years.

Your decision, then, depends largely on your expectations about your tax bracket.

If you do decide to go ahead and claim, it's a good idea to put the tax savings in an account. Many people figure they will just take the clawback tax out of the proceeds when they sell the property. But if you fell out with your partner and moved back home, or the two of you moved into your house, the clawback would happen then, with no house sale to help you out.

If you should decide not to bother with depreciation, tell Inland Revenue that on your upcoming tax return. Otherwise it's possible you could end up facing a clawback later on, even if you didn't claim depreciation.

Question: We own a rental property which we have had for several years which unfortunately became a leaky home.

After much discussion and investigation it was suggested by building experts the best way forward was demolition back to the concrete floor. This was suggested because of the complexity of design, original workmanship and condition of the property.

Indications were it would be quicker and possibly cheaper to repair, and we could salvage as many reusable items as possible ie windows, doors, kitchen etc.

The house has been rebuilt to the original floor plan and used the same, but new, exterior finish. We have never claimed depreciation on the house.

Our question is will the repair costs be tax deductible against future earnings?

Answer: That's a tricky one. You might be able to deduct the costs as maintenance.

They might, however, be regarded as capital improvements, in which case the costs could normally be depreciated over the years. But as you have never claimed depreciation - and presumably made that election with Inland Revenue - you probably can't start doing so now.

The dividing line between maintenance and capital improvements is a fine one. It depends largely on whether the work simply maintains the property's value or improves it.

In your case, it sounds as if an argument could be made either way. There's a lot of money at stake. It's time to talk to a tax expert or Inland Revenue.

* Mary Holm's advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following her advice. Send questions to mary@maryholm.com or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice.

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