Residential rental tax changes

Does property investment still make sense? 

by Anne Stephenson - Connected Accountants Director

In March 2021, the government announced a number of changes to residential rental tax rules aimed at disincentivising investors from buying existing residential rental properties and making investment into new builds more attractive.  The main changes were increasing the bright-line test period from 5 years to 10 years and limiting interest deductions from October 2021 onwards for anything other than new build properties. 

There’s no legislation yet but a discussion document does provide some idea of current thinking.   

Certain properties excluded

The following types of properties will be most likely excluded from the new rules

• Land outside New Zealand
• Employee accommodation
• Farmland
• Care facilities – hospitals, nursing homes, hospices, etc.
• Commercial accommodation such as hotels, motels, boarding houses
• Retirement villages and rest homes
• Main homes that also generate income - where an owner-occupier has flatmates or boarders.
• A dwelling added to vacant land – built or relocated after 27 March
• An additional dwelling added to a property after 27 March, whether stand-alone or attached
• A dwelling (or multiple dwellings) that replaces an existing dwelling after 27 March
• Alterations to an existing dwelling after 27 March to create two or more dwellings – including a secondary dwelling, attaching a new dwelling to an existing one, and splitting an existing dwelling into multiple dwellings
• A dwelling converted after 27 March from commercial premises (e.g. an office) into apartments
• Purpose-built student accommodation (eg halls of residence)
• Papakāinga housing on Māori land

The key focus of the new rules is to include property that is designed for long-term residential use, regardless of whether it is used in that manner.  For that reason, an Airbnb property and any other short-lease property would most likely be caught by the new rules unless it meets the new build definition.

The discussion document suggests an investment property that was acquired new before 27 March will be subject to the limitations on interest deductibility, which seems unfair.

Mixed Commercial & Residential property

A number of commercial properties are used to provide accommodation and are best considered on a case by case basis.  Where the accommodation is ancillary to another function of the property (e.g. a hospice), they will not be impacted.  Where the supply of accommodation is the core function of the business (e.g. a hotel or motel) but the property cannot easily be made suitable for an owner-occupier, they will also not be impacted.  The concept is that if the building is of a type that would not normally be generally available for owner occupation, then it will be excluded from the new rules.  Bed & breakfast operations where the owner lives onsite could potentially be problematic and we look forward to draft legislation.

A dual-purpose property on a single title- (e.g. retail downstairs, a flat upstairs) is already subject to business premises exclusion for the bright-line test which operates on an all-or-nothing basis.  If that same all-or-nothing approach were applied, it could result in inequitable results.  For example, if business use is more than 50% of the total area then it would be excluded from the new rules (full interest deductibility), and if it were 50% or less then it would be caught (zero interest deductibility).  A fairer approach might be to allow an apportionment of interest. 

Serviced Apartments

Serviced apartments can provide long-term and short-term accommodation and fall within the existing bright-line test rules.  Serviced apartments can be like hotel rooms but they can also most resemble a residential apartment.  The former will most likely be carved out from the rules, while the latter are most likely to be caught by the new rules.

Separate dwelling at main home

It is most likely that a separate dwelling (e.g. self-contained flat or cottage) on the same land as a main home would fall within the new rules. 

Eligibility to new build exemption

It is proposed that the new build exemption based on date of issue of the Code of Compliance Certificate (CCC).  Where CCC is issued after 27 March 2021 the new build exemption will apply.  Where CCC for a new build was issued before 27 March 2021 and settlement takes place after 27 March but within 12 months of issue, the new build exemption will apply. 

There is no exemption for a new build acquired before 27 March 2021.  So an investor who took possession of a newly built property in February 2021 would not be able to deduct interest outside the 4 year transitional period.

Consideration is being given to whether the exemption would apply in perpetuity or whether it should apply for a fixed period.  Also under consideration is whether the new build exemption is available to subsequent purchasers of a new build for a fixed period of, say, 10- 20 years.

Rollover relief is proposed where there is no change in the economic ownership of the property – for example where the land might be transferred to a family trust, look-through company (LTC) or partnership.  Ordinarily, these might trigger the bright-line test or make the transitional interest claim unavailable.

There has also been some consideration of interest deductions at the time of sale of a property where profits become taxable as a result of the bright-line test.  A full or partial deduction of interest at the time of sale makes sense.

Next Steps

Consultation on the discussion document has closed and the new tax bill should be introduced by 30 September when these rules take effect.  While we understand the need to address housing affordability, tax law changes tend to be a blunt instrument and we fully expect there will be unintended consequences.  

The proposed changes involve some technically complex rules and do not always fit neatly within existing tax legislation so some level of incoherence is inevitable. 

As a means of growing wealth and passive cashflows, residential housing still makes sense notwithstanding the lack of interest deductibility.  The changes will also tilt the field more towards growing wealth through equity investments.  The long term investment returns have residential property only slightly ahead of equity investments.