Dear clients,
The Minister of Finance, Hon Grant Robertson, has announced proposed changes for residential property acquired on or after 27 March 2021. The proposed changes include:
• extending the bright-line test to 10 years
• amending the main home exclusion which would require tax to be paid on gains made for periods the property is not used as the owner’s main home
• allowing newly built homes to use a 5 year bright-line test
• not allowing property owners to claim interest on loans used for residential properties as an expense against their income from those properties. This would start from 1 October 2021 and would also be phased in over 4 years for existing properties. There would be an exemption for newly built homes.
The current law
Currently when owners of residential investment property calculate their taxable income they can deduct the interest on loans that relate to the income from those properties (claimed as an expense). This reduces the tax they need to pay.
What is being changed
The Government has agreed to change the rules that allow property owners to claim interest on loans used for residential properties as an expense against their rental income from those properties.
The legislation will apply from 1 October 2021.
Interest deductions on residential investment property acquired on or after 27 March 2021 will not be allowed from 1 October 2021. Interest on loans for properties acquired before 27 March 2021 can still be claimed as an expense. However, the amount you can claim will be reduced over the next 4 income years until it is completely phased out, as shown in the table on the next page. This means that in the 2025–26 and later income years, you will not be able to claim any interest expense as deductions against your income.
If money is borrowed on or after 27 March 2021 to maintain or improve property acquired before 27 March 2021, it will be treated the same as a loan for a property acquired on or after 27 March 2021. Interest on it will not be able to be claimed as an expense from 1 October 2021.
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.
When a property is acquired
For tax purposes, a property is generally acquired on the date a binding sale and purchase agreement is entered into (even if some conditions still need to be met).
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.
Interest Deductibility for New Builds
Grant Robertson has said the Government is still considering the interest deductibility for New Builds and will consult IRD and property consultants.
Property acquired before 27 March 2021
If you acquired a property before 27 March 2021, you can still claim interest (for loans that already existed for that property) as an expense against your residential property income, but this amount will reduce by 25% each income year until the ability to deduct the interest is completely phased-out from the 2025–26 income year. If you have a standard balance date, the proposed change will be phased in as follows
Income year | Percent of interest you can claim |
1 April 2020–31 March 2021 | 100% |
1 April 2021–31 March 2022 (transitional year) | 1 April 2021 to 30 September 2021 - 100% 1 October 2021 to 31 March 2022 - 75% |
1 April 2022–31 March 2023 | 75% |
1 April 2023–31 March 2024 | 50% |
1 April 2024–31 March 2025 | 25% |
From 1 April 2025 onwards | 0% |
Property acquired on or after 27 March 2021
If you acquire a residential property on or after 27 March 2021 and take a loan out to acquire it, you cannot claim interest on that loan as an expense against your property income from 1 October 2021 onwards. This means you'll pay more tax on any property income you receive. You can still claim other expenses such as the cost of insurance and rates.
Offer made before, but property acquired after, 27 March 2021
If you've made an offer on a property on or before 23 March 2021, but the offer is accepted after 27 March 2021, and you could not withdraw the offer before 27 March 2021, your property will be treated as if it was acquired before 27 March 2021, meaning you can claim interest as an expense until the ability to deduct it is completely phased-out.
Borrowing on or after 27 March 2021
If you incur additional debt (from drawing on the same loan or taking a new loan) on or after 27 March 2021, and the use of the loan relates to the investment property, interest on that portion of the loan will not be able to be claimed as an expense from 1 October 2021 onwards.
Loans for business use secured against residential property
The Government's intention is that the rule change will not apply to loans for non-housing business purposes. In addition, property developers and builders will still be able to claim their interest expenses.
Extension of the bright-line test to 10 years
The bright-line test means if you sell a residential property within a set period after acquiring it you will be required to pay income tax on any profit made through the property increasing in value. The current bright-line period is 5 years. The Government has announced it intends to extend the bright-line period to 10 years for residential property except newly built houses (new builds). 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.
To determine what length of bright-line test a property is subject to the following flow-chart can be used. The section on the next page explains when property is acquired for these purposes.
When a property is acquired
For tax purposes, a property is generally acquired on the date a binding sale and purchase agreement is entered into (even if some standard conditions like getting finance or a building report still need to be met).
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.
The date you acquire property determines whether the bright-line period is 5 or 10 years. This will also determine which set of rules relating to the main home exclusion and change of use will apply to your property. In either case, the period is then counted from the date the land is transferred to you (generally the settlement date).
There will be consultation on what will be considered a new build
The definition of a new build will be worked out in consultation with the tax and property communities over the coming months, but it is intended to include properties that are acquired within a year of receiving their code compliance certificate under the Building Act 2004.
Legislation to define 'new builds' and exclude them from the proposed 10-year test is intended to be introduced into Parliament after consultation. The Government intends for the legislation to be retrospective such that new builds acquired on or after 27 March 2021 would continue to be subject to a 5-year bright-line test.
Changes to the treatment of times when a property is not the owner's main home
The government is making the rules fairer around the change of use of a main home with respect to the operation of the bright-line test.
Any residential property that has been used as the owner's main home for the entire time they owned it will continue to be exempt from any 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.
If a property switches to or from being the owner's main home and the period when it is not their main home is 12 months or less, they do not need to count that as a change-of-use – those non-main home days are 'treated as' main home days. For example, if an owner takes a few months to move into a property, or owns it for a few months after moving out, this does not trigger the bright-line test.
The owner of a property subject to the change-of-use rule will be required to pay income tax on a proportion of the profit made through the property increasing in value, calculated as follows:
ï subtract the purchase price from the sale price
ï subtract the cost of capital improvements the owner has made
ï subtract the costs to buy and sell the property, and
ï multiply the result by the proportion of time the property was not being used as the owner's main home.
If a residential property was acquired on or after 29 March 2018 and before 27 March 2021, the existing main home exclusion rules will continue to apply. These can be found at ird.govt.nz/property. In short, the main home exclusion from the existing 5-year test applies on an all or nothing basis, depending on whether the property was used for most of the bright-line period as the main home. Changes-of-use do not need to be accounted for.
What the proposed changes mean for you
This section describes what the proposed changes mean for you if you acquire a residential property on or after 27 March 2021.
If you sell the property more than 10 years after acquiring it (or 5 years for a new build), you will not pay tax under the bright-line test on any gain in value.
If you sell the property within 10 years of acquiring it (or 5 years for a new build), and it was your main home for the entire time you owned it, you will not pay tax under the bright-line test on any gain in value. However, if the property was your main home, but was used for other purposes for more than 12 months during the time you owned it, you must pay income tax on the profit from the gain in value of the property as detailed in the previous section.
If you sell the property within 10 years of acquiring it (or 5 years for a new build), and it was never your main home for the entire time you owned it, you will pay tax under the bright-line test on any gain in value.
Any profit from a gain in property value that is considered taxable income (including under any of the bright-line tests) will also affect any other obligations or entitlements you have based on taxable income, such as student loan repayments, child support payments, and Working for Families. This effect would be in the year you need to include the income on your tax return.
Short-stay accommodation
The legislation will also ensure that residential properties used to provide short-stay accommodation, where the owner does not live in the property, are subject to the bright-line test, and cannot be excluded as business premises.
Other land sale rules still apply
There are other rules in the Income Tax Act 2007 that can tax gains on the sale of land (including residential land). For example, there are tax rules that apply to speculators, land developers and dealers. Those rules will continue to apply, regardless of when the property was purchased. The bright-line tests potentially apply only if none of the other land sale rules apply.
Regardless of the bright-line tests, anytime you purchase property with the intention of selling it you must pay tax on the profit unless an exemption applies.
I hope this is of some assistance.
Yours faithfully
LOWTHERS CHRISTCHURCH LIMITED
Ellen Loke B.Com CA PP
DIRECTOR
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