The changes are being included in an existing Tax Bill currently going through Parliament (at select committee stage), but will generally have effect from 1 October 2021. The proposals released in the draft legislation may change as a result of the select committee and parliamentary processes, and further public submissions may be invited by the select committee.
Based on the draft legislation released, residential investment properties capable of being used for long term accommodation would be subject to the proposed rules. However, the following exclusions and exemptions are proposed:
- An exclusion for the main family home
- Exclusions for several types of residential property, and
- Exemptions for new builds and for property development.
A set of information sheets is available providing general information about how the proposed rules are intended to work, and a summary of these points can be found below:
- Interest deductibility proposals at a glance
- Properties not affected by the interest deductibility proposals
- How the rules work for certain entities
- Exemptions for property development and new builds
- How interest deductions are affected
- Changes to the bright-line property rule
1. Interest deductibility proposals at a glance
The proposal is that, from 1 October 2021, interest will not be deductible for residential property acquired on or after 27 March 2021. For properties acquired before 27 March 2021, generally investors’ ability to deduct interest will be phased out between 1 October 2021 and 31 March 2025. Some properties are excluded from these rules and some exemptions are proposed.
To minimise any impact on housing supply, property development and new builds will be exempt from the proposed rules. The main home and commercial property will also not be affected by the interest limitation proposal.
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2. Properties not affected by the interest deductibility proposals
In general, any house, apartment, or other such building in New Zealand that a person could live in would be affected by these changes. Bare land that could be used for residential property will also be affected. It does not matter whether the property is rented out long-term, used for short-stay accommodation, or even left vacant.
Certain properties will be unaffected by these rules. This means that if you satisfy the other requirements for claiming deductions, you will still be able to deduct interest for these properties.
Main homes are not affected by these changes. You generally can’t claim interest deductions for private use, but if you use your main home to earn income (such as from a flatmate or boarder), you will be able to deduct some interest against that income.
Provided you meet the other requirements for claiming deductions, you will still be able to deduct interest against income from these unaffected properties:
- A portion of the main home if it is used to earn income (for example, from flatmates or boarders).
- Properties used as business premises (except for an accommodation business), like offices and shops. This includes residential properties to the extent they are used as business premises (for example, a house converted into a doctor’s surgery).
- Hospitals, hospices, nursing homes, and convalescent homes.
- Retirement villages and rest homes.
- Hotels, motels, hostels, inns, campgrounds.
- Houses on farmland.
- Bed and breakfasts where the owner lives on the property.
- Employee accommodation.
- Student accommodation.
- Land outside New Zealand.
In addition, the proposals also include a land “business” exemption and a “development” exemption.
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3. How the rules work for certain entities
The proposed changes are generally intended to apply to all property owners. However, specific proposals deal with how companies, developers and social housing providers will interact with the rules.
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4. Exemptions for property development and new builds
To encourage the supply of new housing, the Government is proposing exemptions from the rules denying interest deductions.
Exemption for business developing land
The land business exemption will apply for interest relating to land if you hold that land as part of a developing, subdividing, or land-dealing business, or a business of erecting buildings on land. Interest relating to remediation work and other expenses from ownership and development of the land will also qualify if this exemption applies.
Exemption for other property development
If you do not qualify for the land business exemption, the development exemption will apply for interest relating to land that you develop, subdivide, or build on to create a new build. You can only deduct interest if existing tax rules allow you to, even if you qualify for the exemption.
The exemption will apply from the time you start developing the land and end when you sell the land or receive a Code Compliance Certificate (CCC) for your new build. Once your new build receives its CCC, the new build exemption will apply instead.
Interest relating to remediation work done to an existing property that is not significant enough to create a new build will not qualify for this exemption.
Exemption for new builds
The new build exemption will allow you to deduct interest (provided it is deductible under existing tax law) from either the date you acquire a new build or it receives its CCC, and expires 20 years after the new build receives its CCC.
The exemption will apply to anyone who owns the new build within this 20-year fixed period, and the timing of the exemption will not reset when the property is sold.
A new build will generally be defined as a self-contained residence that receives a CCC confirming the residence was added to the land on or after 27 March 2020. It will also include a self-contained residence acquired off the plans that will receive its CCC on or after 27 March 2020 confirming it has been added to the land.
If you convert an existing dwelling into multiple new dwellings, this can qualify as a new build. So too can converting a commercial building into residential dwellings.
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5. How interest deductions are affected
For property investors who borrowed to acquire residential property before 27 March 2021, interest deductions will be phased out between 1 October 2021 and 31 March 2025 as shown in the table below. Residential property investors who borrow to acquire residential property on or after 27 March 2021 will not be allowed to deduct interest incurred after 1 October 2021 (unless an exception applies). Certain exemptions apply and certain property types are excluded.
If you borrowed funds on or after 27 March 2021 for your property, interest deductions will no longer be allowed from 1 October 2021 except if you used those funds to purchase property acquired:
- Before 27 March 2021 (for example, you entered into an agreement but settlement was in May 2021), or
- As a result of an offer you made before 24 March 2021 that you weren’t permitted to withdraw before 27 March 2021 (for example, as part of the contractual terms and conditions in a tender process).
If either of these exceptions applies, your ability to deduct interest will be phased out according to the table above. Note: If one of the exemptions for property development or new builds applies, your interest deductions will not be limited under the proposed rules.
There are specific rules that apply to determine what interest is deductible and how it is to be apportioned if necessary, for:
- Debt refinancing on or after 27 March 2021
- Variable loans (such as revolving credit or overdraft)
- Borrowing used for non-residential property purposes
- Property rented out and also used privately
- Changes in how property is held after 27 March 2021 (i.e. transfers involving family trusts, LTC’s, partnerships, relationship property settlements and transfers on death)
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6. Changes to the bright-line property rule
Along with proposals to limit the deductibility of interest, the Government has also proposed the following changes to the bright-line property rule:
- A 5-year bright-line property rule for new builds acquired on or after 27 March 2021
- Changes to the main home exclusion to ensure the main home is not taxed
- Changes to how technical transfers of ownership are handled
If you acquire a “new build” on or after 27 March 2021, then a new 5-year bright-line property rule will apply (instead of the 10-year bright-line property rule). You must meet these requirements:
- You must acquire the new build no later than 12 months after it receives its code compliance certificate (CCC).
Your new build must have its CCC by the time you sell it.
Generally, residential property will be considered a new build where a self-contained residence has been added to land, and it has received a CCC confirming this on or after 27 March 2020. Apart from the difference in length, the same rules that apply for the 10-year bright-line property rule will also apply for the bright-line property rule for new builds.
Changes to the main home exclusion
The main home exclusion currently ensures the bright-line property rule does not apply to residential land if you use more than half the land for a main home.
However, the exclusion doesn’t apply if you use less than half the land for a main home. This means that if you use most of the land for a residential rental property and only have a small main home portion, and then you sell your land during the bright-line period, any gain on sale will be taxed. This happens even though you have a main home on the land.
The Government proposes to change the treatment where the main home portion is smaller than the rental property, so that any gain on sale will be apportioned. The gain that relates to the periods the property is used as a main home will not be taxed under the bright-line property rule. The portion of the gain that relates to the rental property would be taxed. This change will apply to all property acquired on or after 27 March 2021. This means it would apply to both the 5-year new build and 10-year bright-line property rules.
Technical changes of ownership will not affect the bright-line property rule
Proposed rollover relief will allow you to change how you hold a property without triggering the bright-line property rule. When the legal ownership of a property changes but the effective ownership is the same, the transfer will be ignored if it is in one of the prescribed situations. This means the original owner will not be taxed on the realised gain on the property, and the new owner will be treated as having acquired the land when it was acquired by the original owner.
Relief will be provided for some transfers to family trusts and for transfers to or from look-through companies and partnerships. Specific relief is proposed for transfers of land subject to the Te Ture Whenua Māori Act 1993 and transfers to trusts as part of settling Treaty claims. This is consistent with the relief proposed for interest limitation purposes.
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If you are unsure how the new draft legislation may affect you or you would like some clarification, please contact your Kendons advisor for more information.