What are the new tax rules for landlords?

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GOVERNMENT ANNOUNCES CHANGES TO BRIGHT-LINE TEST AND INTEREST DEDUCTIONS ON RESIDENTIAL PROPERTY INCOME

The Government has this week announced several proposed changes for residential property acquired on or after 27 March 2021.

The changes include:

  • extending the bright-line test to 10 years (excluding new build homes which will remain at five 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, and
  • not allowing property owners to claim interest on loans used for residential properties as an expense against their income on those properties.

The rules regarding the bright-line test take effect from 27 March 2021, and the rules regarding interest deductions on residential property income will take effect on 1 October 2021.

Interest deductions on residential property income

The current rules

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.

Proposed changes

From 1 October 2021, interest deductions on residential investment property will not be allowed, if the property was acquired on or after 27 March 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 four income years until it is completely phased out. 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 you borrow money on or after 27 March to maintain or improve property (even if the property was acquired before 27 March 2021), you will not be able to claim interest on that loan 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 is a property “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 e.g. building report or finance, still need to be met). IRD have further clarified that for the purposes of this change, a property will also 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.

You can read further detail about these proposed changes here.

Changing the bright-line test

What is the bright-line test?

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 five years.

Extending the bright-line test

The Government has announced it intends to extend the bright-line period to 10 years for residential property except newly built houses (new builds).

The definition of a “new build” is still being worked out, but is intended to include properties that are acquired within a year of receiving their code compliance certificate.

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.

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.

Change-of-use rule

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:

  • subtract the purchase price from the sale price
  • subtract the cost of capital improvements the owner has made
  • subtract the costs to buy and sell the property, and
  • multiply the result by the proportion of time the property was not being used as the owner’s main home.

You can read further detail about these proposed changes here.

Our experienced property law team is happy to help if you’d like to discuss how the new rules will affect you – click here to view our property law team.