There have been a lot of announcements from the government around tax deductibility changes for rental properties and brightline test extensions.
But how am I affected? What are the specifics of the new tax changes? Is the current house I live in liable to these changes also?
If you’re a property investor (i.e. you own one or more rental property) or are wanting to become a property investor, then keep reading. In this article, we will go through the most commonly asked questions posed by New Zealand property investors regarding the government’s new tax changes.
What are the changes that have been announced by the government?
The government recently announced two significant changes to its housing policy.
The first change is that the brightline test will now be extended from 5 years to 10 years on residential investment properties brought after March 27th, 2021. New builds will be exempt, and will remain at the current 5 year brightline rule.
The second change is that interest costs can no longer be deducted from residential investment properties brought on or after March 27th, 2021. For rental properties already acquired, interest deductions will be phased out over the next four years.
These changes aim to target both buy and flip property investors and buy and hold property investors.
Let’s look at the brightline test changes first:
What is the brightline test?
The bright-line property rule means that people who sell a residential property might need to pay income tax on any profit if the property is sold within a certain time period.
The bright-line period starts on the date you bought the property, which is the date the property’s title is registered with LINZ (usually the settlement date) and ends when you enter into a binding Sale and Purchase agreement to sell the property.
Are there any exemptions of the brightline test?
Yes – the test does not apply if the property is:
– Predominantly used as the owner’s main home
– An inherited property
– A new build (New builds will continue to be subject to a 5 year brightline period, see the definition of a new build below).
Now let’s delve into the new interest cost changes:
Currently, property investors are able to deduct interest costs from their rental properties.
Typically, property investors calculate their taxable income by calculating their annual rent, minus operating costs (such as rates, property management fees etc.), minus interest costs.
ANNUAL RENT
– OPERATING COSTS
– INTEREST COSTS
= PROFIT
THEN
PROFIT
-TAX
= TAKE HOME PROFIT
Now with the new policy change, property investors will not be able to deduct interest costs. This means that many property investors will have to pay, in most cases, a lot more tax and some properties that used to make investors money will now run at a loss.
ANNUAL RENT
– OPERATING COSTS
– INTEREST COSTS
An example of this:
Let’s say you have an investment property that yields $450 per week in rental income. That equates to $23,400 per year in rental income.
Hypothetically, your operating costs (rates, property management fees, maintenance etc.) are around $8,500 for this property and your interest costs are $10,000 (with your loan for the property being $400,000 and your interest rate at 2.5%)
Rent ($450 per week) – $23,400
minus Operating costs – $8,500
minus Interest costs ($400,000 at 2.5%) – $10,000
= Profit – $4,900
THEN
Profit – $4,900
minus Tax – $1,617(33% of the taxable profit)
= Take home profit: $3,283 per year
With the new government changes, property investors won’t be able to deduct interest costs from their rental properties as IRD no longer recognises interest costs as a tax deduction.
This means our formula now looks like this:
Rent ($450 per week) – $23,400
minus Operating costs – $8,500
= Profit – $14,900
THEN
Profit – $14,900 (interest costs are now included as profit)
minus Tax – $4,917
= Take home profit: $-17 per year
Profits on a rental property are now seen as a lot higher due to the interest costs no longer being deductible. The take home profit for this property is now $-17 per year as opposed to $3,283 per year meaning it is now negatively geared.
When is this change being implemented?
Unfortunately, this rule change has already been implemented. If you’re a property investor who acquired a property before March 27 2021, you can still claim interest on pre-existing loans as an expense against your residential property income, but this will be phased out over the next five tax years as shown below:
Are there any exemptions?
Yes, new builds will be exempt from the new tax rules. New builds include:
Simple new builds (adding one or more self-contained dwellings to bare residential land)
– Adding a dwelling to bare land
– Replacing an existing dwelling with one or more dwellings
Complex new builds (adding one or more self-contained dwellings to residential land that already has an existing dwelling on it, without a separate title being issued for the new build portion)
– Adding a standalone dwelling
– Attaching a new dwelling to an existing dwelling
– Splitting an existing dwelling into multiple dwellings
“These new builds are considered complex because the presence of an existing dwelling on the land means apportionment is likely to be required for both the new build exemption from interest limitation and the new build bright-line test.” (Inland Revenue)
Commercial properties that have been converted into residential properties.
We know that this is a lot of information to take in and have tried to simplify these changes down to their bare bones in order to help our clients understand these key changes.
If you are wanting more information, there are a great number of resources available on Inland Revenue’s Tax Policy site and tips for current property investors from business.govt.nz.
Needing to reassess your current property portfolio or talk about getting started as an investor? Get in touch with Jeff for advice on your current mortgages by booking in for a 15 minute chat.
