Our last two articles on the recent property tax changes displayed an extreme desire from the Government to cool the housing market by specifically changing tax rules that target property investors.

These property investors aren’t limited to multi-millionaires owning multiple properties but include your average mum and dad investor with a rental property or those with a holiday home. In addition to the extension of the bright-line test and changes to the main-home exclusion, the Government has proposed to eliminate income tax deductions for interest on borrowings in relation to residential investment properties.

Whilst no legislation has been introduced to Parliament as yet, the Government has advised that income tax deductions for interest on a residential investment property acquired on or after 27 March 2021 will not be allowed from 1 October 2021.  Income tax deductions for interest on loans for properties acquired before 27 March 2021 will be phased out over five years. These taxpayers will claim interest deductions based on the below table.

However, even if the investment property was acquired before 27 March 2021, if additional debt is borrowed on or after 27 March 2021, and the use of the loan relates to an investment property, then interest will not be able to be claimed for income tax purposes from 1 October 2021.

Example

Ana acquired a rental property in 2017. Ana is charged $1,250 interest each month ($7,500 every six months). Anna has a 31 March tax year.

For the 2020-21 tax year Ana claims 100% of the $15,000 annual interest deductions. For the 2021-22 tax year Ana claims 100% of the interest charged between 1 April 2021 to 30 September 2021 ($7,500). Between 1 October 2021 and 31 March 2022 Ana is charged $7,500 of interest but can only claim 75%, which is $5,625. The total interest Ana can claim for the 2022 tax year is $13,125.

Assuming Ana has a 33% tax rate and applying the above phase out method Ana will have the below additional tax to pay each year:

These rules will not apply to loans borrowed for non-housing business purposes or to property developers. 

The Government will also consult on whether an exemption should apply to new builds, and whether people who are taxed on the sale of a property should be allowed an income tax deduction for interest at the time of the sale. As previously stated, there is no legislation yet and the devil will be in the detail. If there are any changes we will provide details of these in another article.

We are concerned that the Government is overcomplicating the tax system and adding unnecessary compliance costs to a significant amount of taxpayers. Because of this, people who may have not previously needed a Chartered Accountant to complete their income tax return, may now need to.

This tinkering with the tax system is proof that some of the Government’s other policies to tackle the housing boom have not worked. The Government brought in the loss-ring fencing rules to “level the playing field between property speculators/investors and owner-occupiers…and that there is an argument that [rental housing] is under-taxed.

Having to bring in this new policy basically means the loss ring-fencing rules have not achieved the intended outcome. 

The Government believes these tax changes “level the playing field between property speculators/investors and owner-occupiers”.  However, the elimination of income tax deductions for interest in respect of residential rental property investments now means that the “tax” playing field between different types of investments is no longer level.  If a taxpayer borrows funds to invest into shares, commercial property, or a business, then they are entitled to claim an income tax deduction for the interest on these borrowings.  Why should the income tax treatment for interest on borrowings related to a residential rental property investment be any different?

One of the best aspects of New Zealand’s tax system is its broad base, low rate approach, and simplicity.  These changes, along with the other property changes, challenge this and somewhat complicate our relatively simple tax system.