Residential Property Bright-line Test And Interest Deductibility Rules: What You Need To Know
Earlier last year the Government announced a number of measures designed to make the housing market more accessible to first home buyers. Changes to the tax system, in particular, were proposed to counteract the perceived favourable conditions for property investors.
The first key change was the extension of the bright-line test for taxing profit on residential property sales, doubling from a 5 year to a 10 year catchment period. The 10-year bright-line test applies to residential properties purchased on or after 27th March 2021. Exceptions include new builds (5 year bright-line period), inherited properties, and main homes (although an apportionment calculation applies where the property is not always used as the owner’s main home, resulting in a portion of the gain on disposal being taxable).
The second major change to be introduced was the removal of deductions for interest on residential rental properties. Applying from 1st October 2021, interest deductibility is not permitted on residential rental properties purchased on or after 27th March 2021, and interest on loans for properties purchased before that date is on a reducing basis over four years until completely phased out:
These new measures essentially constitute a capital gains tax in disguise, and at the time of the announcement were estimated to have the ability to bring in additional revenue of $1.82 billion for the Government. The majority of New Zealanders who have invested in residential rental property will no longer be able to claim tax deductions on interest incurred, and the market may well see rents rise in a bid to offset these new rules.
There are some exemptions to these new rules. For example, the removal of interest deductibility does not apply to new builds (for 20 years after issue of the Code of Compliance Certificate (CCC), where the CCC was issued on or after 27/03/2020 and the property was acquired no later than 12 months after CCC). Exemptions also apply to certain types of residential property such as houses on farms, hotels, retirement villages and social housing, among others. Generally, property developers can still claim interest on houses they develop for sale. It is also worth noting that where interest deductions are not permitted, they can still be claimed if the property ends up being taxed under the bright-line test, with the deduction being permitted in the year of disposal. Note that loss ring-fencing still applies, so interest that is not caught by the new rules will still be ring-fenced if there is a net rental loss.
There is a great deal of detail in the new rules and how they apply vary depending on specific circumstances. If you would like further information on how these rules may apply to you, please contact us – we’re here to help.