The “bright-line” test for taxing gains from the sale of residential investment property is being extended from 5 to 10 years with effect from 27 March 2021.
Interest deductibility on residential property will be removed from 1 October 2021. This rule will apply to all property acquired on or after 27 March 2021, with a phasing in of the rule for existing investments over a 4 year period.
Tax Policy Officials have indicated the bright-line period extension is not intended to apply to “new builds”. The Government will also consult on whether the proposed interest deduction restrictions should apply to new rental builds later this year.
What: The bright-line property rule for residential property
Who: Anyone buying and selling property bought on or after 1 October 2015
Old ruling: If you sell a residential property you have owned for less than 5 years you may have to pay income tax on the capital gain of the property. This rule also applies to New Zealand tax residents who buy overseas residential properties.
For any properties purchased from 27 March 2021 onwards, the “bright-line” test, which taxes gains made on the sale of residential investment property, will be extended from 5 to 10 years.
This means that any properties purchased from 27 March 2021 onwards will effectively be subject to a capital gains tax if sold within 10 years. The one key exception to this is for new builds, which will continue to be subject to a 5 year brightline test. This incentivises an increase in the supply of housing stock rather than purchasing existing housing stock.
Introduces a new “change of use” rule for residential investment properties acquired on or after 27 March 2021. For example, if a residential property was used as a main home for six out of eight years, 25%(6 years / 8 years) of the gain on sale in year eight will be taxable. The change in use rule will apply to both existing and new builds but property that is sold within 12 months of a change of use will not be taxed.
The Bright-line extension was not entirely unexpected given the state of the housing market and impacts property speculators rather than traditional owner occupied property.
It is worth noting that for our clients that hold investment properties or that are looking to purchase investment residential properties in the future this may affect your tax position.
WE would encourage you to touch base with us to understand the correct accounting treatment moving forward so WE can ensure you are in compliance with your investment.
Removal of interest deductibility
For a new residential investment property acquired on or after 27 March 2021 interest incurred on a loan used to help fund the purchase will not be tax deductible. There may end up being a key exception to this rule for new builds.
The Government is considering allowing interest incurred on loans used to fund investments in new builds to continue to be tax deductible for the same reason as allowing a concession under the bright-line test.
For properties acquired prior to 27 March 2021, the ability to deduct interest will be phased out and reduced, per the timeline below:
|Income Year||Percent of interest that can be claimed|
|31 March 2021 (FY21)||100%|
|31 March 2022 (FY22)||1 Apr 2021 – 30 Sep 2021: 100%
1 Oct 2021 – 31 Mar 2022: 75%
|31 March 2023 (FY23)||75%|
|31 March 2024 (FY24)||50%|
|31 March 2025 (FY25)||25%|
|From 1 April 2025 onwards
(year ending 31 March 2026 and later)
The new law will come in from October 1
- The Government may exempt new builds.
- These changes won't apply to loans for non-housing business purposes.
- Property developers and builders will also not be affected by this rule change.
- If money is borrowed on or after March 27 2021 to maintain or improve the property bought before March 27, it will be treated the same as a loan for a property acquired on or after then.
The most surprising change was the Government's decision to completely eliminate interest rate tax deductions, which investors can currently claim on properties. This means investors can no longer offset the cost of the interest they pay on their mortgage against their tax bill.
If the interest tax deduction is not permitted, the interest costs are no longer tax-deductible. This will make some rental properties significantly more profitable, pushing property investors to another tax bracket which will require additional tax to be paid.
Alternatively, this may make some already low cash flow positive properties, loss-making, making them less appealing investments with investors having to pay tax on negatively geared properties.
WE would encourage our clients to touch base with us to understand the implications surrounding tax accounting treatment to ensure both you and your investment are in compliance.
Possible Consequences and Other Changes
In the short-term, with changes being phased-in over several years and interest rates at an all-time low, investors with existing properties may not feel the full effect of the proposed changes until interest rates start to rise.
Removing the ability of interest deductibility will add a considerable amount to the cost of providing rental property which will discourage new investors from entering the market for existing homes.
Allowing interest deductions for new properties only (which will be confirmed later in the year) will likely make new properties more desirable driving up prices attached to new builds. As a result, we will likely see the knock on effect to the cost of building as demand increases so does competition to secure building.
Depending on the debt and structure level existing residential landlords might struggle to hold lower cashflow properties or properties with high mortgages.
Without interest deductions, investors will look to increase returns to justify their property investment. This may lead to higher rents (although they will be restricted by the tenant's ability to pay).