- Are interest deductions for rental properties lost or just delayed?
- A “fairer” change of use rule does not necessarily mean a simpler one
- Exactly what will the 5-year rule look like for ‘new builds’?
It’s somewhat unusual in New Zealand for major tax policy announcements to be made without consultation, and for policy to be set in stone before the legislation is even drafted. While the extension to the bright-line test came as no surprise, interest deductibility changes did. Despite, or perhaps because of, the sudden announcement and partial enactment of the changes several grey areas still exist.
Interest deductions, delayed but not lost?
On 23 March 2021 Government announced that from 1 October 2021 interest deductions would not be allowed on residential investment properties acquired on or after 27 March 2021. For properties acquired before 27 March the amount of interest that can be claimed is being phased out gradually before being completely removed from 1 April 2025.
At the time of writing the interest deductibility announcement has not been enacted and Government has signalled its intent to consult on the details of these proposals. Our expectation is that Government will want to move quickly to finalise the legislation.
The key focus of this consultation will be whether Government will allow people who are caught by the bright-line test and pay tax on the sale of their property – to deduct their interest expense at the time of sale. While this may come as a relief to investors who feel targeted by these recent changes, it is not a guarantee. CA ANZ would not expect a deduction to be allowed if the property is sold at a loss. Residential property investors who hold the property for more than 10 years would not be eligible to deduct their interest expenses at the time of sale under this model.
Change of use: how many bites of the pie can you get?
Under the old five year bright-line test, a person’s main home was excluded if it met a ‘predominant use test’ i.e., it was used as your main home for more than 50% of the time you owned it and you used more than 50% of the property’s area. The later part was particularly important for those with a rented granny flat, or who ran an airBnB
For properties that are subject to the new 10 year bright-line period, a “change of use” rule has been introduced. The fact sheet released in conjunction with the announcement states that “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.” If the situation falls outside of the 12 month ‘buffer’, income tax must be paid on the proportion of the property that was not used as the main home.
Here’s a potential example. Sarah purchases her home in Auckland in April 2021. She owns no other properties. In June she is seconded to Wellington for six months, and in this time rents her home in Auckland. At the end of her secondment she returns to her main home in Auckland. However, in June 2030 Sarah decides to undertake significant renovations ahead of the sale of her property, buying and moving into a new home in Hamilton while this process is underway. The 10-year bright-line period expires in April 2031. In total there are two periods where the Auckland property was not Sarah’s main home, six months in 2021, and 10 months in 2030-31.
While it’s not beyond doubt, the fact sheet and legislation appear to suggest that this is allowable. The legislation provides slightly more detail, stating that the change of use from being a main home, must be within a continuous period of 365 days or less. The commentary to date does not appear to include any limitation on the frequency of which the non-main home change of use “buffer” can be used during the bright-line period.
It’s likely we’ll see Inland Revenue issue clarification or guidance covering this issue.
Definition of a new build, and what the 5-year test will entail.
The definition of a ‘new build’ will be finalised in legislation later in the year but is intended to capture properties acquired within a year of receiving code of compliance.
New builds will be excluded from the 10 year bright-line test. Instead they will be subject to a five-year test. What is ambiguous in the fact sheet is whether this is the five-year test that applied before 27 March 2021 (and therefore has the predominant use test to main home exclusions) or whether it’s a new test which shares the features of the 10-year test – including the requirement to undertake a change of use apportionment.
Let us know your thoughts
The NZ Tax Team welcomes thoughts and feedback from members on all aspects of the residential property announcements and changes and we will be making a submission when consultation is announced.
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