Major changes were recently announced by the Government to try and cool the overheating New Zealand housing market. These focused on:
- Extending the bright-line test to 10 years
- Allowing newly built homes to use a five-year bright-line test
- Requiring tax to be paid on gains made when the property is not used as the owner’s main home
- Not allowing property owners to claim interest on loans used for residential properties as an expense against their income from those properties.
This means that property owners 1) may need to pay income tax on any profit made through the property increasing value, and 2) are no longer be able to offset their interest expenses against rental income when calculating their tax.
We explain below how the changes might affect people when buying or selling investment property.
Extending 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 gains made from an increase in property value.
This has been extended from five years to 10 years for residential property acquired on or after 27 March 2021.
The following table shows which properties will be affected by the new rule.
|Inherited properties||Exempt from bright-line test|
|Owner’s main home for the entire time they owned it||Exempt from bright-line test|
|Properties acquired before 29 March 2018||Exempt from bright-line test|
|Properties acquired on or after 29 March 2018 and before 27 March 2021||Remains at five-year bright-line test|
|New builds||Remains at five-year bright-line test|
|Properties acquired on or after 27 March 2021||10-year bright-line test|
There will be consultation with the tax and property communities over the coming months to help determine the definition of a new build. The intention is to include properties that are acquired within a year of receiving its code compliance certificate.
The Government will introduce legislation defining new builds and exclude them from the 10-year test following consultation.
For residential properties acquired on or after 27 March 2021, the Government is introducing a ‘change-of-use’ rule. This rule also applies to new builds.
If a property switches to or from being the owner’s main home for more than 12 months at a time, the owner of the property will be subject to the change-of-use rule and will be required to pay income tax on a proportion of the profit made through the property increasing in value.
This will be calculated as follows:
- Subtract the purchase price from the sale price
- Subtract the cost of capital improvements
- Subtract the costs to buy and sell the property, and
- Multiply the result by the proportion of time the property was not used as the owner’s main home.
Properties acquired before 27 March 2021 are exempt from the change-of-use rule.
If you sell the property within 10 years (or five years for a new build) of acquiring it, and it was not your main home, you will have to pay tax under the bright-line test on any gain in property value.
Similarly, if the property was your main home, but was used for other purposes (such as rented out) for more than 12 months during the time you owned it, you will need to pay income tax on the profit from the gain in value.
Residential properties purchased and used for short-term accommodation (such as Airbnb), where the owner does not live in the property, will also be subject to the bright-line test and cannot be excluded as business premises.
Changes to interest deductions on residential property income
From 1 October 2021, interest deductions on residential investment property acquired on or after 27 March 2021 will no longer be allowed.
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 years until it is phased out completely.
From 2025-26, you will not be able to claim any interest expense as deductions against your income.
|Percent of interest you can claim||100%||100% (1 April 2021-30 Sept 2021)
75% (1 Oct-31 Mar 2022)
If money is borrowed on or after 27 March 2021 for maintenance or improvements to property acquired before 27 March 2021, it will be treated as a loan for the acquired property. This means you will not be able to claim interest as an expense from 1 October 2021.
Property developers will not be affected by this change as they pay tax on the sale of the property. They will still be able to claim interest as an expense.
The Government will consult on the detail of these proposals and legislation will be introduced shortly thereafter. Consultation will cover an exemption for new builds acquired as a residential investment property, and whether all people who are taxed on the sale of a property (for example under the bright-line test) should be able to deduct their interest expense at the time of the sale.
These new proposed rules will affect genuine landlords, i.e people who have purchased property for long-term purposes with the intention to derive rental income. This increases their tax and compliance costs and therefore they will be bound to pass on some of these costs to their tenants. This is likely to lead to an increase in the rents and/or possibly a decline in the properties being available for rental. We trust the Government will take this into consideration when introducing the Bill for these new proposed rules.
If you are a residential property investor you need to consider these new rules as you may end up paying tax on gains made when selling the property down the track or seeing less returns with a higher tax bill each year.
Need more information?
IRD has prepared two fact sheets on the bright-line test and interest deductions on residential property income, with several examples to help clarify the proposed new rules.