Investment property tax tips - interest deductibility on rental properties
In September 2021, the government proposed draft legislation that changed the way that rental properties are taxed. It did not have an immediate impact on most investors but it is starting to be a discussion point for people looking to rent their properties. My experience is that most people are not very knowledgeable about the tax rules because they are not professional landlords. Many people are accidental landlords through inheritance and not by choice.
These rule changes are probably the most impactful tax changes in the history of property investment in New Zealand. Most people who own a rental property will no longer be able to claim a tax deduction for the interest on the mortgage attached to the property.
Under the interest denial rules, no interest may be claimed from 1 October 2021 for residential property purchased on or after 27 March 2021.
For property bought before 27 March 2021, these rules are phased in with:
75% of the interest claimable from 1 October 2021 to 31 March 2023
50% claimable from 1 April 2023 to 31 March 2024
25% claimable from 1 April 2024 to 31 March 2025; and
no deduction at all for interest incurred in borrowing to acquire residential property from 1 April 2025 onwards.
Fortunately there are exemptions, and those details have just been released. You can download the report on the IRD website here: Special report on interest limitation and additional bright-line changes (ird.govt.nz).
The first of these is that the new rules don’t apply to the same extent to “new builds”. A new build is a property that received its code compliance certificate on or after 27 March 2020. Interest relating to new builds is eligible to be deducted for up to 20 years from the time the property’s code compliance certificate is issued. This exemption will apply to both the initial purchaser of the new build and any subsequent owner within the 20-year period. Should you start investing in New Builds in Dunedin?
The bright-line period for new builds (again using the same definition based on the issue of a code compliance certificate) is reduced from 10 years to five years.
Under this definition it is the issue of the code of compliance that makes it a new build, not the age of the building. So, an office building that is converted into dwellings, or an existing dwelling converted into multiple new dwellings, could qualify.
There are also exemptions for certain types of residential property such as houses on farms, certain Māori land, retirement villages, hotels, hospitals, social housing, employee or student accommodation, and land outside New Zealand. Owner-occupiers who rent rooms of their main home to tenants are also excluded.
Companies that own residential houses will also generally be exempt from the rules, provided their main business does not involve residential land. Unless that is, five or fewer individuals or trustees own 50% or more of the company.
If a property has both residential property and non-residential property on the same title, only the portion of the interest that relates to the non-residential property can be deducted.
Property developers can generally still claim interest on houses they develop for sale.
Where interest is denied, it can still be claimed if the property ends up being taxed under the bright-line rules. The deduction is allowed in the year of disposal.