The Brightline rule and interest deductions – what’s changing and what does it mean?

In February the government announced some pretty major changes to the property tax rules. The aim of the game here is to help even the playing field between first home buyers and property investors. There are many opinions on it, but we thought we’d take a look at how it will affect us and what it all means.

So, what are the changes?

  • A bright-line period extension

The bright-line rule currently provides that the profit made off the sale of a residential property is taxable if sold within five years of acquisition (and the property is not your main home). This means the profit from the sale of a property could be hit with a tax of up to 39%.

This is now being extended to 10 years for residential property acquired on or after 27 March 2021. Property acquired before 27 March 2021 (and after 29 March 2018) remains subject to the five-year bright-line test. You can find more information on this here.

  •  Interest deductions

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. From 1 October 2021 no deduction will be available (these rules will apply to residential property acquired on or after 27 March 2021).

Interest on loans for property acquired before 27 March 2021 remains deductible however on a reducing basis over the next four years (a progressive 25% reduction each year); with no deductions (for any residential property acquired at any time) for interest from 1 April 2025 onward. This does mean the impact will be spread over time and best to discuss how this will affect you over the coming years with your accountant. You can find more detail on this here.

Why is this happening?

The government has launched these policies as a way of addressing New Zealand’s surging house prices. It’s intended that the changes will mean house price increases will slow, providing more opportunities for first-home buyers, and less competition from investors.

And what do we think this really means?

In terms of the bright-line extension, there’s a lot to think about (and it’s not just large-scale investors it’s going to affect). For example, you could be a family homeowner living overseas and intending to return to your home – but if you rent it out for more than 12 months the bright-line rule will be triggered.

Life is unpredictable, circumstances change – in the case of a divorce (and the need to split your assets) being forced to sell a rental property within 10 years may trigger the bright-line rule if it has been a rental during your ownership. This is very common in the Auckland marketplace.

Independent economist, Tony Alexander has come up with a good example of how the interest deductions are going to potentially affect your bottom line;

‘it means if one anticipated buying a property delivering $20,000 per annum in rent, financed with debt costing $15,000 in interest, then ignoring all other costs, taxable income would have been $5,000. The tax bill would be $1,650 at 33% and the investment would be cash flow positive.

Now, tax will be levied on the entire $20,000 of revenue delivering a tax bill of $6,600. The tax bill goes up to $4,950 and the property is now cash-flow negative.

In reality, these are going to affect the up and coming, younger generation of rental investors the most. This potentially does not change a huge amount for the owners with long-term, mortgage-free properties who have the capital to invest in new properties with low mortgage repayments and are able to hold onto the property for longer than 10 years at a (potential) loss.

There is also a real possibility rents may well rise because investors will look for compensation for their inability to deduct interest costs.

Any exemptions here?

Yes!

These do not apply to new build homes – this was initially unclear and we still do not have a firm definition of a ‘new build’ but the government has recently confirmed that these new rules will not apply to new build homes (see an article detailing this announcement here).

There is also the ‘main home’ exemption. Your ‘main home’ is the property where you live for most of your time (or if you have more than 1 property it is the one you have the greatest connection to). This also means if you rent part of your own home (via a granny flat for example) then as long as more than 50% of the home is classed as your ‘main home’ then they also do not apply.

There is a bit more detail to these! So for the full breakdown please see the breakdown on the IRD website.

The positives

This is all with the aim of helping first home buyers who are struggling to get a foot on the ladder – and we can already see things easing in the market since these announcements.

These were not the only announcements; an infrastructure fund (of $3.8 billion) to unlock a mix of private sector-led and government-led developments in locations facing the biggest housing supply and affordability challenges.

There is also additional funding for the Land for Housing Programme to accelerate the development of vacant or underutilised Crown-owned land, in order to deliver a broader range of affordable housing options for rental and homeownership.

And finally, from Thursday, 1 April 2021, the income caps for First Home Loans and Grants will increase and the house price caps will increase in targeted areas.

For further detail refer to the HUD Fact Sheet and the Kāinga Ora website.

We know there’s a lot to digest here, both negatives and positives. We recommend all owners chat to their accountant for advice on how the above might affect you and your investment, each situation is unique and will require seperate analysis and planning – or get in touch, we are happy to help and connect you with some accounting experts should you need.

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