As the Labour government seeks to ‘cool’ the property market, property investors in New Zealand will see an increase in the amount of tax payable, with a significant impact on their rental income and property sale proceeds.
The Labour government will implement the amending law in stages. Our recommendation is for property investors to seek advice early and understand the consequences at each stage of this transition – when looking to buy or sell a property. In this article, we highlight possible impacts on you as an investor and examine how your investments could become less profitable.
A LONGER BRIGHT-LINE TEST
A bright-line test is a mechanism that essentially taxes gains made on residential property sold within a specific timeframe (subject to a limited number of exemptions).
The initial timeframe for the bright-line test was two years. However, the Labour government extended the bright-line test to five years in March 2018.
Now three years down the track, our Labour government is extending that bright-line test from five to ten years – with a few exceptions.
- The extended test will not apply to newly built homes, and as was the law before,
- No bright-line test applies to inherited properties,
- No bright-line test applies to ‘main home’ properties, owned for the entire time for that purpose.
The government also introduced a new ‘change of use rule’ that will affect how tax is calculated during the bright-line period. If the property is not being used as the owner’s main home for more than 12 months or if the use of the property has been changed for less than 12 months, there will be no tax implications.
Whether a property is subject to the extended ten-year bright-line test depends on when you acquired the property. If you acquired the property before 27 March 2021, the five-year bright-line test would still apply. This includes properties purchased by way of an offer made on or before 23 March 2021 that could not have been withdrawn before 27 March 2021.
All properties acquired after 27 March 2021 will be subject to the extended ten-year bright-line test, meaning if the property is sold within ten years from the date of purchase, the gains made will be taxable.
PHASING OUT INTEREST DEDUCTIONS
The government’s announcement also amends the laws surrounding interest deductions on residential property income.
Previously, owners of residential investment properties could offset the interest payable on loans relating to the property as an expense, reducing the overall amount of tax owing. When calculating profits under the old structure, property investors generally use this equation –
Annual rent – Operating costs – Interest costs = Taxable profit.
Over the next four income years, the amount claimable will reduce in increments and eventually abolish interest deductions by the end of the 2024/2025 financial year.
The legislation will take effect from 1 October 2021, with the practical implementation occurring in stages.
Interest deductions will not be claimable as an expense for properties acquired on or after 27 March 2021. Money borrowed on or after 27 March 2021 to maintain or improve a residential property obtained before 27 March 2021 will be tax-deductible until 1 October 2021.
For properties acquired before 27 March 2021, a phased approach of 25% reductions in the amount claimable has been introduced. Meaning you can claim 100% of the interest paid as an expense for the financial year ending 31 March 2021. Then in the 2021/2022 financial year, the transitional period 100% interest can be claimed for the first half of the financial year and then dropping to 75% claim ability for the second half of the financial year. From 1 April 2025, interest deductibility for residential investment properties will no longer be allowed.
Once the new tax structure is in place, property investors will calculate their taxable profits under the new equation –
Annual rent – Operating costs = Taxable profit.
The consequence for investors is that their profits will appear greater before tax, which will result in a higher tax bill for investors, depending on the type of investment property.
AN EXCEPTION TO INTEREST DEDUCTIONS
The new tax laws will not apply to all investment properties and investors equally.
Properties considered to be a ‘new build’ will still be entitled to claim interest costs and won’t be affected by the new laws.
What constitutes a new build is still under consideration by the Government, but it will likely include:
- Any property bought directly from a property developer
- Properties with a code of compliance issued within 12 months of the purchase date
For more information, see the governments rules under the First Home Grant for a comparative definition of a new build.
Property investors, especially those new to the industry, should take the time to ensure they understand what these changes mean for them and how they wish to proceed under the new law. The government is still consulting on aspects of the new legislation, so property investors must remain vigilant to ensure they are compliant in this area.
FOR MORE INFORMATION