The Government has announced two significant tax proposals aimed at residential property in an attempt to tackle the housing crisis. While the Government has talked about extending the bright-line test for some time, the proposed change to deny interest deductions will have caught many by surprise.
Officials state “the proposals….are a part of the Government’s response to reduce investor demand for property. Decreasing the tax advantage that property investors can receive will reduce the amount investors are prepared to pay for a given house and the number of houses they will buy. The measure is intended to support first home buyers and help lift New Zealand’s home ownership rates”.
Extension of bright-line test to 10 years
The first proposal is to double the bright-line period for residential property from 5 to 10 years. This means that residential property acquired on or after 27 March 2021 will be subject to tax if disposed of within ten years of acquisition. Say if a residential property is acquired on 1 May 2021, the owner will need to hold on to it for at least 10 years to escape tax under the bright-line test (unless it is their main home, or another exception applies).
There will be an exception for newly built houses, which will continue to be subject to the current five-year bright-line test. The Government intends to consult on the definition of a “new build” over the coming months. One possibility is that properties acquired within one year of receiving a code of compliance certificate under the Building Act 2004 will be included in the definition.
Properties subject to an offer made on or before the date of the announcement (23 March 2021) will be treated as being acquired prior to 27 March 2021 if the offer is not able to be withdrawn before 27 March 2021. The 5-year bright-line period will continue to apply to these properties.
The Government is also changing the rules around the main home exclusion to the bright-line test. Currently, a property is either fully in or fully out of the main home exclusion, with a simple 50 percent threshold to establish whether the owner uses the property as their main home. This will change for properties purchased on or after 27 March. From that date the main home exclusion applies only for the time that home is actually used as the owner’s main home. A 12-month buffer operates before this rule kicks in, meaning the main home exclusion can still apply if not used as a main home for less than 12 months. The sale proceeds will then be taxable, but an adjustment will be permitted, the result being that tax will need to be paid on any gains made during the period of time that the property was not used as the main home.
Removal of interest deductions for residential property
The second proposal concerns the removal of interest deductions in respect of residential rental properties. The Government intends to consult with stakeholders about these proposals, however, the following is a summary of what the Government is proposing.
Interest on residential property acquired on or after 27 March 2021 (with the exception of new builds) will not be deductible at all.
For existing residential property, the ability to claim interest deductions will be phased out progressively over four years. Interest will be deductible in the usual manner up to 30 September 2021, after which only a percentage will be claimable until it is completely phased out, as set out in the following table:
|Income year||% of interest that can be deducted|
|1 October 2021 to 31 March 2022 (2022 income year)||75%|
|1 April 2022 to 31 March 2023||75%|
|1 April 2023 to 31 March 2024||50%|
|1 April 2024 to 31 March 2025||25%|
|1 April 2025 onwards||0%|
Taxpayers who borrow additional funds in relation to the property on or after 27 March 2021 (for example, to make improvements to the residential property) will also be impacted. Interest on that portion of the loan will not be deductible from 1 October 2021.
Property developers (ie those who are subject to tax on disposal) are not affected and can continue to claim interest deductions. Government will also consult on whether there should be a carve out from the rules for new builds and whether others subject to tax on disposal (for example, under the bright-line test) should be able to claim the interest when the property is ultimately sold.
Rules likely to have wide impact
While the extension of the bright-line test has been anticipated in an over-heated housing market, the denial of interest deductions goes against a long-standing tax principle which allows deductible expenses to be offset against taxable income. The inability to claim interest (a significant outlay for many investors) will have an adverse impact on cashflow. Many anticipate that this cost will be passed on to tenants by investors, while other property owners may choose to exit the market altogether.