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Residential Property Changes to Bright-line and Interest

With 3 young adults in our family, housing affordability has been a hot topic in recent years as we consider how our kids (or indeed anyone) might one day buy a home of their own.

The housing changes announced yesterday by the Government are intended to help slow the pace of the ever-increasing property prices, and help make first home ownership more achievable.

Whether or not they will achieve the desired outcome is up for debate and there is a lot of emotive narrative in the press at the moment. We’ll try and stick to the facts here but what is clear is the changes are substantial, will have a significant impact on many property investors, and there will be unintended consequences as a result.

We’ve put together a brief summary of the key tax changes impacting residential properties below. Please keep in mind that some of the new policies are yet to be enacted, so there may changes.

The Bright-line Test

  • The bright-line test period has been extended from 5 to 10 years for houses purchased on or after 27th March 2021.
  • This means that if you sell in less than 10 years, you will pay tax on the gain in the value of the property.
  • For new houses, the bright-line period will be set at 5 years.
  • Your main home is still excluded from the bright-line test if you live in it the entire time.
  • But if your main house is also rented at any point then it may be subject to the bright-line rules
  • Short-stay accommodation will also be subject to the bright-line rules even though you are operating it as a business not a residential rental.

Interest Deductibility

  • If you’ve borrowed money to buy a residential rental property, you will no longer be able to claim the interest as an expense.
  • For residential rental properties purchased from 27th March 2021, the ability to claim interest as an expense will be completely removed effective 1 October 2021.
  • For residential rental properties purchased before 27th March 2021, the ability to claim interest as an expense will drop by 25% per year.
  • By 1 April 2025, you will not be able to claim any interest.
  • Property developers will not be impacted as they already pay tax
  • Businesses with loans secured against residential property will also not be impacted.
  • There is still some additional detail to be worked through in the coming months which may include interest remaining deductible if you have purchased a new build.

What does this all mean for you?

Because there are so many variables, the impact will depend on your personal circumstances, and what the property market ends up doing.

The tax changes will mainly impact investors with sizeable mortgages or those looking to sell. If you have a rental property with no mortgage and don’t intend to sell it anytime soon, then it’s pretty much business as usual.

However, if you have borrowed money to purchase a residential rental, then over the next 4 years your tax bill is going to get increasingly larger. That means you’re going to need to consider your options.  

What are your next steps?

As always, don’t let the tax impact be the sole driver for any decisions you make. If you are likely to be affected by the changes to residential housing we suggest:

  • Panic slowly – a knee-jerk reaction is never helpful.
  • Start by understanding the changes – find out a bit more around the bright-line test and the proposed changes to interest deductibility. In the first instance, we recommend reading the IRD fact sheets rather than relying on what you read in the news.
  • Crunch the numbers – what is the likely impact of the changes on your cashflow? Does residential property investment still make sense to you? 
  • Consider the alternatives – investment in commercial property, the share market or in a business are now more appealing from a tax perspective, but also carry their own risks.
  • Wait and see – doing nothing is always an option. And it may be the best approach initially as we wait for the interest deductibility legislation to be finalised and see what the housing market does.
  • Get advice – tax implications of decisions around residential properties just got significantly more complicated. If you are planning on buying or selling property please get advice before you make decisions to avoid any unintended tax issues.