Property investors will no longer be able to offset their interest expenses against rental income when calculating their tax.
This is one of three tax measures announced today by the Government as it attempts to cool the overheating New Zealand housing market.
The others include:
- Extending the bright-line test to 10 years.
- A ‘change-of-use’ rule within that test which will apply when a property is not used as the main home for more than 12 months at a time.
Below we explain what each measure means for property investors.
Removal of interest deductions
Currently when residential investment property owners calculate their taxable income they can deduct the interest on loans that relate to the income from those properties.
They can claim this as expense, therefore reducing the tax they need to pay.
However, the Government has decided to change the rules to remove residential investment property owners’ ability to do this.
The legislation will apply from 1 October 2021.
From 1 October 2021, you will be unable to claim interest deductions on residential investment property you acquire on or after 27 March 2021.
Interest on loans for properties acquired before 27 March 2021 can still be claimed as an expense.
However, the claimable amount will be reduced over the next four income years until it’s completely phased out.
From the 2026 tax year onward, you will be unable to claim any interest expense as deductions against your income.
If your tax year runs from 1 April to 31 March, the proposed change will be phased in as per the table below.
|Tax year||Percent of interest you can claim|
|2021 (1 April 2020-31 March 2021)||100 percent|
|2022 (1 April 2021-31 March 2022)||1 April 2021 to 30 September 2021 – 100 percent |
1 October 2021 to 31 March 2022 – 75 percent
|2023 (1 April 2022-31 March 2023)||75 percent|
|2024 (1 April 2023-31 March 2024)||50 percent|
|2025 (1 April 2024-31 March 2025)||25 percent|
|2026 (1 April 2025-31 March 2026)-onward||0 percent|
If money is borrowed on or after 27 March 2021 to maintain or improve property acquired before 27 March 2021, it will be treated the same as a loan for a property acquired on or after 27 March 2021.
That means you will be unable to claim interest as an expense from 1 October 2021.
Property developers who pay tax on the sale of property will not be affected by this change and will still be able to claim interest as an expense.
The Government is to consult on the detail of these proposals and will introduce legislation shortly thereafter.
Consultation will cover an exemption for new builds acquired as a residential investment property.
There will also be a decision around whether all people who are liable to pay tax on the sale of a property – for example, under the bright-line tests – should be able to deduct their interest expense at the time of sale.
Bright-line test extension
The bright-line test means if you sell a residential property within a set period after purchasing it you will have to pay income tax on any profit made through the property increasing in value, unless an exemption applies (keep reading).
The Government plans to extend the bright-line test from five years to 10 years.
This will apply for properties purchased on or after 27 March 2021.
However, the test for new build investment properties will remain at the current five years to support the goal of increasing housing supply.
A property acquired on or after 27 March 2021 will be treated as having been acquired before 27 March 2021 – provided the purchase was the result of an offer the purchaser made on or before 23 March 2021 that cannot be withdrawn before 27 March 2021.
There will be consultation with the tax and property communities over the coming months to help determine the definition of a new build.
However, the intention is to include properties that someone acquires within a year of the property receiving its code compliance certificate.
The Government will introduce into Parliament legislation defining ‘new builds’ and excluding them from the 10-year bright-line test following consultation.
It intends for the legislation to be retrospective.
As such, new builds acquired on or after 27 March 2021 will continue to be subject to the five-year bright-line test.
The family home and property that you inherit will continue to be exempt from the bright-line test.
Introduction of change-of-use’ rule
For residential properties acquired on or after 27 March 2021, including new builds, the Government intends to introduce a ‘change-of-use’ rule.
This will affect the way you calculate tax under the bright-line test if you do not use the property as your main home for more than 12 months at a time within the applicable bright-line period.
If a property switches to or from being your main home and the period when it is not your main home is 12 months or less, you do not need to count that as a change-of-use.
Put simply, you can treat those non-main home days as main home days.
Those subject to the change-of-use rule will have to pay income tax on a proportion of the profit made through the property increasing in value.
You will calculate that as follows:
- Subtract the purchase price from the sale price
- Minus the cost of capital improvements you have made
- Subtract the costs to buy and sell the property; and
- Multiply the result by the proportion of time you were not using the property as your main home.
Existing main home exclusion rules will still apply if a property was acquired on or after 29 March 2018 and before 27 March 2021.
IRD has prepared two fact sheets about the removal of interest deductions and the extension of the bright-line test:
- Interest deductions on residential property income – proposed changes
- Bright-line test proposed changes
Both contain examples that illustrate how the department will apply the proposed changes.
There is also a section on the IRD website regarding tax on property.
Talk with your accountant
We recommend you speak to your accountant if you have any questions about how these changes impact you as a property investor.
If you don’t have an accountant, here is a directory of tax advisers we work with across New Zealand. One of these firms will be able to steer you right.