Rental Properties, Bright-line Tests & Interest Deductions
For decades, owning a rental property has been the backbone of many a kiwi family’s retirement plan. In some cases, leveraging the equity in their own homes, landlords have bought properties with no money down. In the last ten to fifteen years, strong growth in house prices has put political pressure on successive Governments to make housing more affordable. The primary tool used by all of the main political parties has been to make rental property investment less attractive, thereby encouraging investments in other areas.
On 23 March 2021, the Government announced the most recent changes to the rules for landlords. The two main changes are the extension of the bright-line test from five years to ten years and the removal of the tax deductibility of interest for rental properties.
On 1 October 2015, the “Bright-line test” was introduced for property owners. At the time this meant that if you sold land less than two years after you bought it you had to pay tax on any equity gains you made in the property; the family home being exempt from this rule.
From 29 March 2018 this was changed to five years, and now, from 27 March 2021 onwards, this has been extended to ten years.
Apart from your family home, if you now buy residential land and sell it less than ten years later, you will pay tax on the equity gains from the property. Currently, the proposed change will let newly built houses have a five year “Bright-line test” though the details for how this would work in practice have not yet been finalized.
It is important to note that the family home may not always be exempt.
If the family home is owned by a trust where the people living in the house are not the settlors of the trust, it probably won’t be exempt.
If the family home is rented out for a year or two while the owners are overseas and then sold less than ten years after it was bought, it would only be partially exempt from the “Bright-line test”.
More information about the proposed changes is available from the IRD website.
Key Take Away Message
If you buy a property after 26 March 2021 you may have to pay tax on the equity gains if you sell it less than ten years later.
If you bought a property after 28 March 2018 you may have to pay tax on the equity gains if you sell it before the five years is up.
If you are thinking about selling a property and are unsure whether you will be subject to the “Bright-line test” or not, please contact us before you commit to selling it. These rules apply to everyone, not just landlords.
From 1 October 2021 interest will no longer be tax deductible for money borrowed after 27 March 2021 for rental properties. This includes new loans for renovations and repairs to existing rental properties. The tax deductibility for existing loans on rental properties bought before 27 March 2021 will be reduced to 75% on 1 October 2021, then to 50% on 1 April 2023, then to 25% on 1 April 2024 and finally from 1 April 2025 no tax deduction will be allowed for the interest expense on rental properties.
An exemption to this rule was announced for new builds however the details about what constitutes a new build has not yet been finalized.
More information about the proposed changes to interest deductibility is available from the IRD website.
Key Take Away Message
From 1 April 2025 the interest expense for rental properties will no longer be tax deductible, except for new builds. If you bought an existing property after 27 March 2021 or took out a new loan for repairs and maintenance, then interest will no longer be deductible from 1 October 2021 onwards.