New tax rules: What investors need to know

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Although the Government has outlined details of the new legislation regarding the phasing out of property investors’ interest deductions, the new bill also has other effects for property investors.

Tuesday, October 5th 2021, 1:28PM 1 Comment

The Government is limiting the ability to deduct interest to make residential properties a less attractive investment option.

In general, any house, apartment, or other such building in New Zealand that a person could live in will be affected by these changes.

Bare land that could be used for residential property will also be affected.

It does not matter whether the property is rented out long term, used for short-stay accommodation, or even left vacant.

Although the changes were signalled some months ago, the Property Council says they confirm the Government’s lack of ambition in dealing with the housing and rental crisis.

Property Council chief executive Leonie Freeman says while the exemption for new builds is welcomed, it will not incentivise one extra home to be built for a deserving Kiwi family.

The Property Council has been advocating for build-to-rent in New Zealand as a solution to some of the housing woes.

Freeman says it is disappointing the Government hasn’t looked to incentivise a “truly game-changing asset class” which would see more options for Kiwi renters.

“Build-to-rent is flourishing in other comparable countries like Australia and the United Kingdom but the tax legislation does nothing to seize this opportunity for better rental accommodation in New Zealand.

“Ultimately, this means less supply for Kiwi families.”

The Property Council requested the Government specifically exempt build-to-rent developments from the interest deductibility proposal to encourage this new asset class.

“These changes will do nothing to unleash build-to-rent’s potential, sidelining what could have been a potential gamechanger for the local rental market,” says Freeman.

“Finance Minister Grant Robertson is right when he says, ‘tax is neither the cause nor the solution to the housing problem’.

“Our question is, why is it the only lever the Government seems willing to pull?

“You cannot tax your way out of the problem.

“For us to be innovative about solutions the Government has to work with the men and women across the industry who are fighting to increase the options for Kiwis in dire need of better housing,” says Freeman.

She says the country’s recovery from Covid requires all industries to have the best possible opportunity to kick back into action.

“The Government has long said it aims to tackle New Zealand’s housing crisis and help more Kiwis into homes.

“We don’t see any of that ambition in today’s announcement.”

What the tax changes mean

For property investors who borrowed to acquire residential property before March 27, 2021, interest deductions will be phased out between October 1, 2021 and March 31, 2025.

Residential property investors who borrow to acquire residential property on or after March 27, 2021 will not be allowed to deduct interest incurred after October 1, 2021 (unless an exception applies).

Phasing out interest deductions                       

Refinancing on or after March 27

Refinancing up to the level of the original loan will not affect the deductibility of your interest. If the original loan qualified for phasing out, then that treatment remains the same.

Variable loans, such as a revolving credit or overdraft

Deductions for interest on a variable loan will also be phased out as per the table above.

This is provided the amount outstanding (after subtracting any expenditure on deductible or private activities) is the same or lower than the amount that was outstanding on March 27.

If the amount outstanding is higher than the amount outstanding on March 27, 2021, only interest on the amount outstanding on March 27 will be deductible under the phased approach.

Interest on the remainder of the amount outstanding will be non-deductible.

Borrowing used for other purposes

The interest limitation rules will not affect borrowings for non-residential property purposes.

For example, if you borrow against a residential property to buy a truck for a transport business, your interest deductions will not be affected.

If you took out a loan before March 27, and cannot work out how much of the loan was used for residential property and how much was used for other business property, a special transition rule will apply.

Under that transition rule, the loan will be treated as being used to acquire your other business property first (based on the market value of that business property) and then the balance will be applied to the residential property.

Property rented out and also used privately

The interest limitation rules will apply to interest relating to residential property that is rented out some of the time and used privately some of the time. This is the case with many holiday homes.

Interest expenses for such properties will be entirely non-deductible from October 1 unless the interest qualifies for the phased approach because the loan is a pre-March 27 loan.

The interest limitation rules will not apply if the interest relates to income you earn in your main home, for example, from a flatting or boarding situation.

You will still be able to deduct some interest against that income.

Changes in how property is held

Proposed rollover relief will allow landlords to change how they hold the property after March 27 but still allow them to deduct a portion of their interest expense during the interest phase-out period.

Relief will be provided for some transfers to family trusts and for transfers to or from look-through companies and partnerships.

This is consistent with the relief proposed for the bright-line test.

Specific relief is proposed for transfers of land subject to the Te Ture Whenua Māori Act 1993 and transfers to trusts as part of settling treaty claims.

Relief will also be provided for relationship property settlements and transfers on death.

This is in line with existing rollover relief provided under the bright-line test.

Exemption for business developing land

The land business exemption will apply for interest relating to land if the land is held as part of a developing, subdividing, or land-dealing business, or a business of erecting buildings on land.

Interest relating to remediation work and other expenses from ownership and development of the land will also qualify if this exemption applies.

Exemption for other property development

If an owner does not qualify for the land business exemption, the development exemption will apply for interest relating to land that is developed, subdivided, or built on to create a new build.

An owner can only deduct interest if existing tax rules allow them to, even if they qualify for the exemption.

The exemption will apply from the time development of the land starts and end when it’s sold or the owner receives a Code Compliance Certificate (CCC) for the new build.

Once the new build receives its CCC, the new build exemption will apply instead.

Interest relating to remediation work done to an existing property that is not significant enough to create a new build will not qualify for this exemption.

Exemption for new builds

What is a new build?

A new build will generally be defined as a self-contained residence that receives a CCC confirming the residence was added to the land on or after March 27, 2020.

It will also include a self-contained residence acquired off the plans that will receive its CCC on or after March 27, 2020 confirming it has been added to the land.

A new build will not have to be made of new material or constructed onsite, so it can include modular and relocated homes.

If you convert an existing dwelling into multiple new dwellings, this can qualify as a new build. So too can converting a commercial building into residential dwellings.

When does the new build exemption begin?

The new build exemption will apply to allow owners to deduct interest (provided it is deductible under existing tax law) from the dates:

• a new build is acquired – if it already has a CCC or if it is acquired “off the plans”, or

• the new build receives its CCC.

Expiry of exemption for new builds

The exemption will expire 20 years after a new build receives its CCC or when the new build ceases to be on the land (for example, it is demolished or removed), whichever is earlier.

Where a new build is acquired off the plans and before its CCC is issued, the 20-year fixed period will still run from the date of the CCC.

Special rules also apply for hotel/motel conversions, and for new builds that receive their CCC after a significant delay.

The exemption will apply 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.

Companies

It is proposed that the rules will not apply to most companies whose core business does not involve residential land.

This is intended to reduce compliance costs for such companies, as allocating interest costs may be difficult and costly for companies with many different types of assets and sources of funds.

Companies that do not have a core business involving residential property are unlikely to be adding to house price pressures.

These are companies where residential property (including new builds) makes up less than half of their total assets.

However, companies where five or fewer individuals or trustees own more than 50% of the company (referred to as close companies) will generally have to apply the rules even if their core business does not involve residential property.

This won’t apply to close companies that are Māori authorities or wholly owned by a Māori authority (or entities eligible to be Māori authorities).

Such companies are different from other close companies, as they are accountable to a larger member group (even if they are technically close companies because they are owned by a single trust).

Developers

Property developers will not be specifically exempted from the rules.

But it is proposed that their development activity will be so that interest incurred on property developments will continue to be deductible.

Other properties

Provided owners meet the other requirements for claiming deductions, they will still be able to deduct interest against income from these unaffected 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 (except for an accommodation business), like offices and shops. This includes residential properties to the extent they are used as business premises (for example, a house converted into a doctor’s surgery).

• 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 accommodation.

• Student accommodation.

• Land outside New Zealand.

Emergency, transition, social and council housing

If a property is used for emergency, transitional or social housing when an owner leased it to the Crown (for example, the Ministry of Housing and Urban Development or Kāinga Ora) or to a registered community housing provider then interest deductions can still be claimed.

What part of a property is excluded?

If a piece of land which has both a residential property and excluded property on the same legal title such as a two-storey building with a shop on the ground floor and a flat on the top floor, owners will still be able to deduct interest for the portion of the property which is excluded.

They need to use a reasonable method to apportion the interest between the two.

Tags: commercial property landlords new build new build exemption property development property investment tax

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