What the new announcement means for investors

Posted 25 Mar '21

by Anthony Appleton-Tattersall on
Article appears under: About Property Investment, Accounting and Tax, Investment Strategy

The government made a significant housing announcement, in the hope to be seen to be doing more about the runaway housing market. Anthony Appleton-Tattersall explains what this might mean for investors.

It includes a significant near-$4B spent on accelerating housing supply. This should be welcomed, and is well overdue. Hopefully it is more successful than previous attempts, but this will be a matter of wait-and-see.

There are also adjustments to first-home-buyer price limits and income limits. The former were set several years ago and hopelessly out of date. Unfortunately they didn't have the sense to just benchmark these to median (or lower-quartile) house prices, so they'll be out of date again in a year or two.

But more urgently, it includes significant tax changes for owners of residential rental property, namely:

  • Extending the bright-line test to 10 years (except for new builds, which remain 5 years);
  • Amending the main home exclusion which would require tax to be paid on gains made for periods the property is not used as the owner’s main home;
  • Removing interest tax deductions on existing loans used for residential properties, starting from 1 October 2021. To be phased in over 4 years for existing properties. Stated there will be an exemption for newly built homes.

All in all it simply reinforces and underlines that residential rental property is the most highly tax disadvantaged asset class we have.

Bright Line Extension

Much of the media appears to be putting focus on the first point, the extension to the Bright Line time period. This is actually meaningless for most investors.

Besides making the job of accountants a bit more frustrating, there will be almost no impact on the market whatsoever. I have run a specialist property accounting practice since before National introduced the 2-year Bright Line.

Almost no one pays Bright Line tax. In seven years serving property investors, I can think of only two cases where it was paid.

Speculators/traders who buy with intention to sell were always required to pay tax under intention provisions, if you bought to keep it you usually keep it for at least five years.

Bright Line Exclusion Tinkering

On the surface it looks like there's nothing inherently wrong with this. If a property is used as a rental for part of its ownership period, shouldn't some Bright Line tax be paid? Administrative hassle but 'fair' enough.

But huge unfair consequences arise for a specific case which I have mentioned before. Consider a family who buys bare land for their own residence. They take 2 months to pick a building company, build agreed for 8-12 months but takes 16. That's 18 months that they didn't live in the property.

If they sell their home after 6 years of living there (within the new 10 year Bright Line), they will be liable for tax relating to the 18 months it wasn't their main home. How is this justifiable? It's an abomination.

Cessation of Interest Tax Deductions

This was a big one. Highly unexpected by pretty much everyone, and shows a huge misunderstanding of (or active contempt for) the integrity of our tax system on behalf of the legislators.

An underlying principle of almost all modern tax systems is that you receive a deduction for the costs that you incur in producing your taxable income. Changing this is a big move, and changing it only for a single sector is atrocious.

That the government are calling it a "loophole" and patting themselves on the back for closing it genuinely makes my heart drop in my chest. They are at best misinformed and poorly advised, and at worst being intentionally destructive while virtue signalling.

The announcement has stated that for properties acquired on or after 27 March 2021, all interest deductions will cease as at 1 October 2021.

Note that IRD defines "acquired" differently to the way most people naturally do, including much of the media - if you entered into a binding contract last week for a property that settles in April, this is treated as acquiring before 27 March.

New properties my clients are currently in the middle of purchasing range from $500k to $1.3M. Using New Zealand's median house price of $685k and current interest rates on offer of 2.5% this is a $17,000 decrease in deductions - for most people an increase in tax bill of almost $6,000 per year.

For an investor with two or three existing rentals and $1M of debt, their overall effect is $25,000 loss of deductions ($8,500 additional tax) phased in over four years; 25% as at 1 October 2021, then 50%, 75% and 100% as of 1 April 2023, 2024 and 2025 respectively.

Giving people six months notice of a tax increase of this size is abhorrent. But it is my expectation that life will move on, rents will rise, and things will go back to normal soon enough.

For further information on the changes, see the IRD's Fact Sheets on Interest Deductions and Bright Line Changes.

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