Property investors hit by changes to taxable income

The government has announced that it has agreed to change the interest deductibility on residential property income.

The details of these proposals acquired by the Inland Revenue Department (IRD) will be consulted, and legislation will be introduced shortly.

This is an unprecedented move to cool the heated property market. It is viewed as a biased approach from property investors in New Zealand as interest deductibility is disallowed only for residential property investment sector.

The deductions for interest are available for all other kind of businesses and investment.

The Current Law 

Currently, residential investment property owners can deduct the interest on loans from their taxable income to reduce the residual tax payment.

For all investor interest cost is the largest single expense, in the absence of interest deductibility, the taxable income portion would be very high.

Impending Changes

Interest on loans in relation to the residential property acquired before March 27, 2021 can still be claimed as an expense against the property income.

However, this will be phased out in four years.

Interest paid for properties acquired on or after March 27, 2021 will not be allowed to claim as an expense.

The amount of interest to be deducted will be reduced 25% each income year until the interest deductibility completely phased-out.

Effective date: October 1, 2021

Property acquired before March 27, 2021:

*Additional debt occurred on or after March 27, 2021 relating to the investment property will be captured by the new law, which means that interest on the additional debt cannot be claimed as an expense from October 1, 2021.

Property acquired on or after March 27, 2021:

Any interest on loan relating to the residential property acquired on or after March 27, 2021 will not be able to claim as an expense against the property income.

*Non-housing business used residential property, property developers and builders, are exempt from this change.

Impact on residential property market

The government has sent very strong signals that if you are willing to invest into New Zealand property market, you will have to pay tax on rental income and pay tax on any gains made upon sale.

The policy is going to affect all investors who invest with a strategy of Buy and Hold.

This will put off lot of buyers who buy a residential house and let the rent pay off the mortgage. Now, they will have to pay tax each year as the net rental income is likely to supersede the expense. 

Bright-line test (BLT) Extension

The Bright-Line Test property rule means that if you sell a residential property within certain timeframe, you may have to pay income tax on any gains.

This rule does not apply to a person’s main home and inherited properties.

The current period of holding for a property is five years in order not to attract Capital Gains. The income will be taxed at the marginal rate for individuals.

The government intends to extend the period to 10 years except for new builds and legislation will be enacted after consultation.

Below flow-chart has been released by the IRD to determine what is the length of BLT a property is subject to the contents of the following chart:

Application Date

This means, if you have acquired the property before October 1, 2015, the property is not subject to the BLT. There is no need to pay tax on any gain in value.

If you acquired the property on or after October 1, 2015, but before March 29, 2018, which is not used for you main home nor inherited, the property is subject to a two-year BLT.

You will need to pay tax on any profit from gain in value of the property if you sell it within two years.

If you acquired the property on or after March 29, 2018, but before March 27, 2021, which is not used for your main home nor inherited, the property is subject to a five-year BLT.

You will need to pay tax on any profit from gain in value of the property if you sell it within five years.

Any property acquired on or after March 27, 2021 (except new build, main home, and inherited property) will subject to a 10-year BLT. You will need to pay tax on any profit from gain in value of the property if you sell it within 10 years.

*Acquiring date: For tax purpose, a property is generally acquired on the date a binding sale and purchase agreement is entered.

*Main home: Residential property that has been used as the owner’s main home for the entire time. If there is a change-of-use of a property in between, and it is subject to the BLT.

Then, the tax will be calculated based on the proportion of time not being used as the owner’s main home.

Reason for Extension

The main reason for extending the BLT is to deter investor to invest into New Zealand residential property market.

This is a kind of Capital Gains Tax. 

We will have to wait to witness the true effects of this extension.

The effects will be visible in the second half of the year.

Capital Gains Tax overseas has not worked as a deterrent to invest into the property market. It would be interesting to see how this would workout in New Zealand.

Saurav Wadhwa is a Chartered Accountant by qualification. He is the Principal Accountant at IBBZ Accounting Limited, Chartered Accountant & Tax Specialist, located in Botany, East Auckland.