As the dust settles on the Government’s wide ranging residential property tax announcements, many investors are focusing on the proposal to deny interest deductions. This change could significantly increase the costs of holding debt funded rental properties that are not “new builds”. In this article we recap the proposal, and highlight 7 common questions and concerns.
The proposal
To recap, interest on residential property loans is currently deductible, subject to certain limitations (e.g. under the “ring-fencing” and “mixed use asset” rules). The Government has announced its intention to deny these interest deductions. Inland Revenue’s Fact Sheet says that:
- Interest deductions will be phased out over four years for properties “acquired” before 27 March 2021. For properties acquired after 27 March 2021, interest deductions will be denied from 1 October 2021.
- The change will not apply to “new builds” acquired as residential investment properties.
- The change will not apply to property developers (who pay tax on sale). The Government has not decided whether the change will apply to other taxpayers who are taxed on sale (e.g. under the “brightline” test).
- Legislation will be introduced following consultation on these proposals.
Common questions and concerns
Does this mean I pay tax on gross rent?
No – deductions should still be available for other expenditure, e.g. rates, insurance, and repairs and maintenance.
I’ve just signed up to purchase a new rental property. Do I need to settle the purchase before Saturday?
Initial reporting on the changes indicated that the four year phase out would only apply for property acquisitions settled before Saturday. Inland Revenue’s Fact Sheet indicates that is not necessarily the case – Inland Revenue says:
For the purposes of the changes outlined in this factsheet, a property acquired on or after 27 March 2021 will be treated as having been acquired before 27 March 2021, if the purchase was the result of an offer the purchaser made on or before 23 March 2021 that cannot be withdrawn before 27 March 2021
.
What about my Airbnb?
The IRD Fact Sheet is silent on short term accommodation. We assume the changes will apply to short-term rental property loans, on the basis the Government is not intending to incentivise landlords to convert long term rentals to short term rentals.
What if I borrow the money to substantially renovate / improve my rental property?
This depends on how “new builds” are defined for this purpose. On the face of it, the interest denial would apply.
What about my existing carried forward rental tax losses?
The IRD Fact Sheet is silent on carried forward tax losses. In principle, the change should not affect the carry forward and utilisation of such tax losses, but that remains to be seen.
What if I sell within my “brightline” period, and pay tax on sale?
As noted above, the Government will consult on this scenario. In our view an interest deduction in these circumstances should obviously be allowed, but we will need to wait and see where the Government lands on this issue.
What’s the best structure for my investments going forward?
We expect to see more trust and non-look through company structures, with an increased focus on “new build” investments. As always, the right structure will depend on your circumstances. Those looking to restructure should be mindful of the brightline rules, and Inland Revenue’s recent comments about tax avoidance and the 39% tax rate.
Next steps
We recommend that all leveraged rental property investors review the impact of these changes on their investments, and keep a close eye on developments.
