Most residential property investors will in three weeks’ time need to start complying with a major rule change that will see them pay more tax.
The Government in March announced that from October 1, most residential property investors will gradually no longer be able to deduct interest as an expense when paying tax. The rules already apply to investors who bought property on or after March 27.
The move came as a surprise and is aimed at cooling the housing market by easing demand for property by investors.
However, the Government is yet to detail exactly what the rules will look like, and what will constitute a “new build”, which will be exempt from the change.
A spokesperson for Revenue Minister David Parker told interest.co.nz that details would be unveiled at an undetermined date before October 1.
He said it was “likely” the rule change would be introduced through a Supplementary Order Paper (SOP) linked to the Taxation (Annual Rates for 2021–22, GST, and Remedial Matters) Bill.
He said the SOP would go through the full select committee process. The bill was introduced to parliament on Wednesday, and is yet to have its first reading.
Rules might not be set in stone until March 2022
The pinch for property investors is that even if the SOP is published within the next three weeks, it could be tweaked before the bill is passed.
Chartered Accountants Australia and New Zealand tax lead, John Cuthbertson, expected the bill to be passed by March 31, 2022.
So, property investors might have to wait until then before all the details of the rule change are set in stone, even though the change applies from before then.
Uncertainty around new builds
Cuthbertson worried about the uncertainty around the ins and outs of the new rules, and how investors would account for the change with their record-keeping until the bill is enacted.
He said a number of questions also remained around how the change would interact with other tax rules, like the bright-line test and the ring-fencing of rental losses.
Chartered Accountants Australia and New Zealand’s submission to the Government on the proposed interest deductibility rule change and extension of the bright-line test from five to 10 years is over 100 pages long.
Cuthbertson noted the headline issue people want clarity on is around what constitutes a “new build”, exempt from the rule change. For example, is a dwelling considered “new” for five, 10 or 20 years, and does it matter who owns it during that time?
National’s Finance spokesperson, Andrew Bayly, agreed.
“Taxpayers have a right to know how the new interest limitation rules will work in practice: for example, what is the definition of a ‘new build’ and who will be entitled to the concession to deduct interest and for how long; and whether build-to-rent properties will be captured under the interest deductibility rules," he said.
Warning over change being rushed
Bayly wants the change to only take effect on April 1, 2022 - if at all. National has committed to reversing the change if elected to government.
Tax accountant, Terry Baucher of Baucher Consulting, also suggested the change take effect from April.
He didn’t believe this would see investors rush into the market and pump up prices before then, as the message around the fact investors will need to pay more tax in the future has already been delivered.
Without the details of the rule change ironed out, government officials have been unable to estimate how much it would cost investors.
Treasury’s best guess was that it would’ve costed $800 million if fully implemented in 2018/19, and had current interest rates prevailed.
National is also adamant the change needs to go through the proper select committee process, so members of the public have another chance to have their say, before the legislation is finalised.
As for the issue of the tax change likely being enacted via an SOP rather than a stand-alone bill, barrister Graeme Edgeler said this shouldn’t matter, provided the SOP goes through select committee.
SOPs are usually used to make policy changes to a bill after it’s been introduced to Parliament.
Edgeler said the mechanism shouldn't make it harder to update the rules in the future. Using an SOP rather than a separate bill can save Parliament time.
Here’s a brief summary of what the Government has proposed the rules look:
- Deductions for interest expenses on residential properties will be restricted from 1 October 2021.
- Interest deductibility on a mortgage on a residential investment property acquired before 27 March 2021 will be gradually phased out between 1 October 2021 and 31 March 2025. Non-grandparented interest would immediately cease to be deductible from 1 October 2021.
- Interest deductibility on a residential investment property acquired on or after 27 March would immediately cease to be deductible from 1 October 2021, unless an exemption applies.
- Property development and new builds would be exempt from the interest limitation rules. In addition, new builds would be subject to a five year brightline test, rather than the ten year test.
- Non-residential properties (for example commercial or industrial properties) would not be subject to the new rules. Also excluded would be employee accommodation, farmland, care facilities such as hospitals, convalescent homes, nursing homes, and hospices, commercial accommodation such as hotels, motels and boarding houses retirement villages and rest homes.
- The main home would not be affected by the new rules. Interest related to any income-earning use of an owner-occupier’s main home such as a flatting situation would continue to be deductible.
- Community housing providers will not be affected by the interest limitation rules if they are charities or otherwise tax exempt. The Government also proposes to exempt Kāinga Ora and its wholly owned subsidiaries from the interest limitation rules.