On 23 March 2021, the Government announced a raft of changes to property tax including:
Extending the bright-line test to 10 years;
Amending the main home exclusion which will require that tax is paid on gains made during the period when the property is not used as the owner’s main home;
Allowing newly built homes to be subject to a 5 year bright-line test; and
Disallowing interest deductions related to residential rental properties.
Now that the dust has settled a bit and we have seen the legislation and intent of the Government, here is a summary of the changes.
Extending the Bright-line Test to 10 Years
The bill introducing the extension of the bright-line period to 10 years was passed by the Government on 24 March 2021 and is currently awaiting Royal assent.
Residential properties acquired on or after 27 March 2021 will be subject to income tax if they are disposed of within 10 years. 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). 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27 March 2021, if the purchase was the result of an offer the purchaser made on or before 23 March 2021 that cannot be withdrawn before 27 March 2021.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 Government has also indicated that legislation will ensure that residential properties used to provide short-stay accommodation, where the owner does not live on the property, are subject to the bright-line test and cannot be excluded as business premises.
Almost immediately after the announcement, IRD issued a Factsheet on the proposed changes which included a great flow chart which can be used to determine which rules your property is subject to.
Image Source: IRD Fact sheet on proposed changes to the bright-line test published 23 March 2021.
Amending the Main Home Exclusion
The main home exclusion currently works on an “all or nothing” basis - If the property was used mostly as the owner’s main home for the bright-line period, then it is treated as having been the owner’s main home for the entire period and you are not subject to tax on any gain on disposal of the property.
The Government has introduced a “change of use” rule for properties acquired on or after 27 March 2021 which means that if your main home was not your main home for a period of 12 months or more then you will be taxed on a proportion of the gain that is derived from the sale of the property if you sell it within the bright-line period.
As an example, if you lived in your home for 4 years before being transferred to another town or country for work and chose to rent your property until you were sure about the move but after 12 months of renting your property you decide that you want to stay in your new town and decide to sell your home. If the property was purchased after 27 March 2021, you will taxed on 20% (1 year rented / 5 years owned) of the gain that you make on the sale of your property.
A couple of important points to note about the “change of use” rules that are being introduced:
The change of use rules will apply to new builds;
If the change of use is less than 12 months, you are excluded from the change of use adjustment;
If the property was acquired after 29 March 2018 and before 27 March 2021, the existing main home exclusion rules continue to apply.
Newly Built Homes Subject to 5 Year Bright-line Test
The Government has advised that new build residential properties will continue to be subject to a 5 year bright-line test. Further consultation will be undertaken on the definition of a new build but it is intended to include properties that are acquired within a year of receiving their code of compliance certificate under the Building Act 2004.
Legislation to define new builds and exclude them from the 10 year bright-line test will be introduced after this consultation period, however they have advised that they intend for the legislation to be retrospective so that new builds acquired on or after 27 March 2021 continue to be subject to the 5 year bright-line test.
Disallowing Interest Deductions related to Residential Property Income
The Government also announced that interest deductions will be denied entirely for residential properties, except new builds. This change was described as removing tax “loopholes” benefitting property investors that are currently allowing them to outbid first home buyers and current homeowners looking to move in to a new home.
The legislation denying these deductions will apply from 1 October 2021 with interest deductions not being allowed on residential investment property acquired on or after 27 March 2021 from this date. Interest on loans for properties acquired before 27 March 2021 can still be claimed as an expense however the amount that you can claim will reduce over the next 4 years as follows:
If money is borrowed on or after 27 March 2021 to maintain or improve a property acquired before 27 March 2021, the interest on this loan will be treated in the same way as for a loan related to a property purchased after 27 March 2021. This means you will not be entitled to any interest deductions on this loan 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.
The Government has also advised that the new rules are not intended to deny interest deductions for loans secured against residential property but used for non-housing business purposes.
More information, including a variety of worked examples, is available in the Fact Sheet on proposed changes to interest deductions on residential property income which is available here.
Our View on these Changes
The reality is that the housing crisis is being driven by one factor - A lack of supply of housing compared to demand. The Law of Supply and Demand is a basic economic principle that all business students learn - When demand outstrips supply of a product the price of the product will increase to reflect the shortage of supply. That is, those that want to buy the product will compete to purchase the product and drive the price of the product upwards. This is exactly what is happening in the housing market. If you want to get traction and improve the situation then you need to build more houses. The failure of Kiwibuild has shown that the Government just don’t know how to make this happen.
These tax changes introduce further complexity to our tax system and are unlikely to increase the supply of housing. Our tax system is meant to be based on a simple self assessment model, however these ad-hoc changes all over the place are just making it harder and harder for tax payers to comply.
It’s also important to note that the NZ tax system is meant to be based on the principle of equity. Irrespective of how income is sourced, if two taxpayers are in the same position with the same level of income then they should pay the same amount of tax. Subjecting one class of investments to a different tax treatment goes against this principle. These tax changes, together with earlier changes like ring fencing of losses from residential rental property, intentionally make the tax settings on residential investment property quite different to other investments and completely erode equity in the NZ tax system.
Get in touch with the team at Thrive CA if you want to discuss the impact that these changes may have on your situation.