Thursday, 25 March 2021 17:19

Government Property Announcements Re-write the Income Tax Act

Recently, the Government announced a range of measures which in their view address the supply and demand for residential properties (in addition to measures already in force such as the ring-fencing of residential rental property losses). Each of these have the potential to have a major impact on anyone who currently owns, or is considering transacting in, a residential property. The announcements do not apply to commercial properties.

The three main announcements are:

  • Increase to the bright-line test from 5 years to 10 years effective from 27 March 2021
  • Changes to the main home exemption from bright-line test
  • Intention to remove interest deduction on residential properties from 1 October 2021

For detailed information you can refer to the Government’s media statement and fact sheets on the bright-line test and interest deductions. The devil will be in the detail and we are expecting further information as these changes unfold.

While there is no need to panic, it is important you know how the changes could affect your cash flow. We summarise the key points below:

1) Increase in bright-line test from five years to 10 years effective from 27 March 2021

  • The ‘bright-line’ test increases from 5 years to 10 years. That is, investment properties bought after the 27th of March 2021 will be subject to tax on any capital gain if they are sold within 10-years (up from the current 5-year period).
  • However, ‘new build’ properties will be exempt and will remain subject to the current 5-year window (exact definition to be confirmed).
  • Inherited properties and those which have been the owner’s main home for the entire time they owned it will continue to be exempt from all bright-line tests.
  • It’s also worth noting that if you’re considering transferring a property into a new entity, this will likely trigger the re-start of the bright-line test.

2) Changes to the main home exemption from bright-line test

  • For residential properties acquired on or after 27 March 2021, including new builds, the Government intends to introduce a ‘change-of-use’ rule. This will affect the way tax is calculated if the property was not used as the owner’s main home for more than 12 months at a time within the applicable bright-line period.

3) Intention to remove interest deduction on residential properties

  • Ordinarily, you’d subtract your insurance, maintenance, interest, and other costs from the income you get from renting out your property, and you’d pay tax on the profit. These changes mean you remove interest from that equation, so that will increase your profit in the eyes of the IRD, and you’ll be paying tax on a higher amount. This is likely to mean you’ll have more tax to pay, which will most likely be funded from your personal cash flow.
  • For properties yet to settle (bought after March 27th) you won’t be able to claim interest costs at all from October the 1st. For properties you already own this ability will be phased out over the next four years, starting in October. However, ‘new build’ properties may be exempt from these changes, subject to consultation on the changes.
  • Property developers (who pay tax on the sale of property) will not be affected by this change. They will still be able to claim interest as an expense.
  • Consultation will cover an exemption for new builds acquired as a residential investment property, and whether all people who are taxed on the sale of a property (for example under the bright-line tests) should be able to deduct their interest expense at the time of the sale.

The impact in dollars and cents

How much of an existing investment property’s interest cost you can claim will start to diminish over the next four years.

Based on the scenario below, of $700,000 of investment property debt at 3% interest, we estimate the approximate annual cost to be between $735 – $1,023 in year one, and between $5,880 and $8,190 by the time it has been completely phased out. 

Income Year % of interest cost you can claim Cash impact 28% company tax rate Cash impact 30% personal tax rate Cash impact 33% personal/Trust tax rate Cash impact 39% personal tax rate
April 2021 – March 2022 (transitional year) 1 April – 30 September, 100% 1 October – 31 March – 75% $735 $787.50 $866.25 $1,023.75
April 2022 – March 2023 75% $1,470 $1,575 $1,732.50 $2,047.50
April 2023 – March 2024 50% $2,940 $3,150 $3,465 $4,095
April 2024 – March 2025 25% $4,410 $4,725 $5,197.50 $6,142.50
April 2025 onwards 0% $5,880 $6,300 $6,930 $8,190

Please note this scenario doesn’t consider any losses that can be carried forward from previous years and doesn't include any measures to offset the impact, such as increasing rents. Also bear in mind that interest rates are likely to only trend in one direction – upwards!

If you are unsure how these changes affect you or would like some clarification, please contact one of the team today for more information. In the meantime, we will continue to keep you updated.