On top of recent reforms of the Residential Tenancies Act, the majority of residential property investors have the right to feel vilified over the latest tax announcements from the Government. While the intention of the Government may be to allow more first home buyers into the market, the reality for many is that this is simply out of reach and property investors provide a service to the community by providing housing for those who can’t afford or don’t want to acquire a home of their own.
To better understand the
tax changes recently announced by the Government, it is probably helpful to first understand the policy behind these tax rules.
Residential bright-line rules
Tax legislation has always had a provision where a person would be taxed on the profits made from the sale of a property if they acquired that property with an express intention or purpose of disposal (i.e. speculators).
Proving intention had posed problematic so, in 2015, the residential bright-line test of two years was introduced. While some people were caught in the cross hairs, in the tax community we could accept that for most people, where they were buying and selling property within a two-year period, there was likely an aspect of speculation and as such, it would be fair for the profits derived to be subject to tax.
In 2018, as a new Government wanting to be seen to address the highly politicised housing issue, the residential bright-line rule was extended from two years to five.
Commentators were concerned that five years was a long time and as experience would tell us, a person’s life can change significantly in five years – relationships fail, family’s needs change, health falters and jobs may lead some down new paths. None of these life events have any impact on the imposition of the bright-line rules.
While circumstances change and life happens, regardless of the reason why you may now find yourself having to sell your investment property, if you haven’t owned it for the required length of time, you will find yourself having to pay income tax on any profits derived.
Now, for properties acquired on or after 27 March 2021, investors need to own these properties (that are not their “main home”) for a period of at least 10 years, otherwise any profits derived will be subject to income tax - potentially taxed up to 39 percent as the new tax bracket for individuals deriving income over $180,000 from 1 April 2021.
While tax commentators can accept a few innocent people being caught in the cross hairs of the two year bright-line rules, many ordinary New Zealanders will be caught by these new 10-year rules. Remembering that the bright-line rule was introduced to support the “intention” provision, a 10-year rule is a quasi capital gains tax against innocent investors who are not speculators.
New builds will not be impacted by the extension and instead subject to the previous five year bright-line rule. What constitutes a “new build” is yet to be defined but however once it is, the legislation will apply to property acquired from 27 March 2021.
There have also been tweaks to the main home exemption. Previously, to qualify for the main home exemption, a property had to simply be predominantly (ie more than 50 percent) used as a main home for the period of ownership. Now, if that use is less than 100 percent, there will be an apportionment of the profits between the period it was used as a main home and the period in which it was not.
Interest deductibility
Marketed as a ‘loophole’, interest deductibility forms a fundamental premise of our tax legislation – if revenue is taxable, then the costs associated with deriving that revenue is tax deductible. The proposed removal of interest deductions for most property investors is an immoral amendment to the tax system. Tax commentators also question the need for removing interest deductibility given that the ring-fencing of residential losses rule greatly reduces the attractiveness of excessive debt leveraging on investment properties anyway.
Unlike the change in the bright-line period, the removal of interest deductibility will go through the consultation process so there is a small chance that the policy writers may be swayed by the feedback of tax advisors and investors, but as it stands it is proposed that for existing property investments, interest deductions will be phased out as follows:
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NB – for property acquired on or after 27 March 2021, any associated interest costs incurred on that property purchase will be reduced to zero percent from 1 October 2021.
Given the complexities of these changes and a mixture of enacted legislation and intended proposals, it is important to consider your personal circumstances and seek advice from your Moore Markhams advisor to determine the best approach for you.
Prepared by Ashleigh Gilmour, a Moore Markhams associate director and tax specialist. Ashleigh has particular experience in land transactions, business acquisitions, disposals and restructures, tax residency and general corporate tax.