This week the Government has released draft legislative proposals with respect to limiting the deductibility of interest expense for residential property investments and a number of changes to the bright-line rules.
This proposal is the Government’s attempt to make residential properties a less attractive investment option and to help level the playing field for first home buyers.
A summary of the proposed changes include:
- Disallowing interest deductions on residential property income along with some exemptions such as the new build exemption
- A new 5-year bright-line rule for new builds
- Amending the main home exclusion which allows apportionment of gains in certain situations and that the main home is not taxed
- Rollover relief to ensure technical changes of ownership will not trigger the bright-line rules
We discuss this in more detail below:
Interest deductions limitation rules on residential investment property
Interest deductions on residential investment property acquired on or after 27 March 2021 will not be allowed from 1 October 2021. This means that owners can only deduct mortgage interest from 1 April 2021 to 30 September 2021. Thereafter, nothing is allowed. There are proposed exemptions that will exclude some properties from the interest limitation rules.
For properties acquired before 27 March 2021, the investors’ ability to claim interest deductions will be phased out between 1 October 2021 and 31 March 2025. If you have a standard March balance date, the proposed change will be phased in as follows:
|Date interest incurred||Percentage of interest you can claim|
|1 April 2021 to 31 March 2021||100%|
|1 April 2021 to 30 September 2021||100%|
|1 October 2021 to 31 March 2022||75%|
|1 April 2022 to 31 March 2023||75%|
|1 April 2023 to 31 March 2024||50%|
|1 April 2024 to 31 March 2025||25%|
Exemptions from the new interest limitation rules
- Land business exemption
This exemption will apply for interest expense incurred if you hold the land as part of a developing, subdividing, or land-dealing business, or a business of erecting buildings on land. Essentially this exemption will apply for land dealers and those in the business of developing land.
- Development exemption
If you are not a land dealer or a developer, but you are developing, subdividing or building on residential land, you may be eligible for the development exemption and allowed deductions on interest expense relating to creating a “new build”. It is important to keep in mind that even if you qualify for this exemption, you can only deduct interest if this is allowed under the existing tax rules.
This exemption will apply from the time you start developing the land and end when you sell the land or receive a Code Compliance Certificate (“CCC”) for your new build. Once your new build receives its CCC, the new build exemption will apply instead.
- New build exemption
The new build exemption will apply to allow you to claim interest deductions for up to 20 years from the dates:
- you acquire your new build – if it already has a CCC for you acquire it “off the plans”, or
- your new build receives its CCC.
This exemption will be available to anyone who owns the new build within this 20-year fixed period, and the timing of the exemption will not reset when the property is sold.
What is considered a new build?
A new build is defined as:
- a self-contained residence that receives a CCC confirming the residence was added to the land on or after 27 March 2020; or
- a self-contained residence acquired off the plans that will receive its CC on or after 27 March 2020 confirming it has been added to the land.
A new build will not have to be made of new material or constructed on site, so it can include modular and relocated homes. In addition, if you convert an existing dwelling into multiple new dwellings, this is also considered to be a new build, including converting a commercial building into residential dwellings.
Properties not affected by the proposed interest limitation rules
It is proposed that interest deductions will still be available for the following types of properties:
- A portion of the main home if it is used to earn income (for example, from flatmates or boarders)
- Properties used as business premises
- Hospitals, hospices, nursing homes, and convalescent homes
- Retirement villages and rest homes
- Hotels, motels, hostels, inns, campgrounds
- Houses on farmland
- Bed and breakfasts where the owner lives on the property
- Employee and student accommodation
- Maori collectively owned land and housing
- Emergency, transition, social and council housing
- Land outside New Zealand
Changes to the bright-line rule
Along with the proposals to limit interest deductions for residential property income, the Government also proposed 3 changes to the bright-line property rule:
- New Build 5-year bright-line property rule
If you acquire a “new build” on or after 27 March 2021, then a new 5-year bright-line rule will apply. Note in this case, the 10-year bright-line rule will not apply to the new build.
To qualify for the new build 5-year bright-line rule, you must also meet the following requirements:
- You must acquire the new build no later than 12 months after it receives its CCC
- Your new build must have its CCC by the time you sell it.
2 .Changes to the main home exclusion
The current main home exclusion prevents the bright-line rules to apply if you use more than half of the land for a main home. However, this exclusion doesn’t apply if you use less than half of the land for a main home.
For example, if you use most of the land for a residential rental property and only have a small main home portion, any gain on sale during the bright-line period will be taxed. The Government proposes to change the treatment in scenarios like to ensure that only the portion of the gain relating to the rental property would be taxed.
3. Technical changes of ownership will not trigger the bright-line test
The proposed rollover relief will allow you to change how you hold a property without triggering the bright-line rules. Essentially when the legal ownership of a property changes but the effective ownership is the same, the transfer will not be caught by the bright-line test (subject to strict restrictions). For example, there will be relief for some transfers to family trusts and for transfers to or from look-through companies and partnerships.
This rollover relief will apply to transfers of residential land occurring on or after 1 April 2022.
How can we help?
We appreciate that the above proposed changes are complex and embedded in an intricate set of draft legislations. Please note these draft proposals will be considered by Parliament and may change.