Residential Interest Deductibility – 7th October 2021
Release on proposed limitations for residential property
Proposed changes to the Brightline Test and residential property interest deductibility were announced by the Government in March this year. Inevitably, this has left many people wondering what this will mean for them. While the details regarding the new build criteria and exemption relief for new build properties were not outlined, the Government has released a discussion paper to determine what the rules will look like. Because the changes are still in the discussion phase, they are not set in legislative stone just yet. However, we have pulled a set of resources together to come up with a useful summary of the proposed main changes to residential interest deductibility, as well as the proposed changes to the Brightline Test for residential properties.
Application to residential property:
The new interest deductibility rules apply to residential property with exception of new builds and property development. Generally, any residential investment property in New Zealand that is suitable for people to live in long-term will be affected. Typically, this would mean a house or an apartment, whether it is used for providing short-term or long-term accommodation and will also include vacant land.
Further Exemptions:
- Borrowings for business purposes will remain fully deductible.
- Commercial property interest deductions will remain fully deductible.
- Land outside New Zealand will not be affected.
- A portion of the main home if it is used to earn income (for example, from flatmates or boarders).
- Houses on farmland will still be allowed interest deductibility.
- Bed and breakfast where the owners live on the property.
What if part of my property is affected and part is excluded?
If you own a property which has both a residential property and excluded property on the same legal title, such as a two-storey building with a shop on the ground floor and a flat on the top floor, you will still be able to deduct interest for the portion of the property which is excluded. You’ll need to use a reasonable method to apportion the interest between the two.
Exemption for new builds:
What is a new build?
A new build will generally be defined as a self-contained residence that receives a Code Compliance Certificate (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.
A new build will not have to be made of new material or constructed onsite, so it can include modular and relocated homes. If you convert an existing dwelling into multiple new dwellings, this can qualify as a new build.
When does the new build exemption begin?
The new build exemption will apply to allow you to deduct interest from the dates:
- You acquire your new build – if it already has a CCC or you acquire it “off the plans”, or
- Your new build receives its CCC.
Expiry of exemption for new builds
The exemption will expire 20 years after a new build receives its CCC or when the new build ceases to be on the land (for example, it is demolished or removed), whichever is earlier.
Where a new build is acquired off the plans and before its CCC is issued, the 20-year fixed period will still run from the date of the 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. The exemption can effectively be passed down from owner to owner over a 20-year period.
Key date for phase out of interest deductibility versus immediate non-deductibility: 27th March 2021.
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. Interest will be fully deductible up to the 30th September 2021.
Phasing out interest deductions for properties acquired before 27 March 2021
Date interest incurred | Percentage of the interest that can be claimed |
1 April 2020 to 31 March 2021 | 100% |
1 April 2021 to 30 September 2021 | 100% |
1 October 2021 to 31 March 2022 | 75% |
1 April 2022 to 31 March 2023 | 75% |
1 April 2023 to 31 March 2024 | 50% |
1 April 2024 to 31 March 2025 | 25% |
Some unique situations:
Refinancing on or after 27 March 2021
If you had existing residential property borrowings pre-27 March 2021 there is the possibility to refinance subsequent to this date. Refinancing up to the level of the original loan will not affect the deductibility of your interest. If the original loan qualified for phasing out, then the refinanced loan treatment remains the same.
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
The bright-line property rule means that if you sell a residential property you have owned for less than a specified period, you may have to pay income tax on any gain.
The bright-line period that applies depends on when the property was acquired:
When the property was acquired | The bright-line period that applies |
On or after 27 March 2021 | 10 years |
Between 29 March 2018 and 26 March 2021 inclusive | 5 years |
Between 1 October 2015 and 28 March 2018 inclusive | 2 years |
New build bright-line property rule
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.
Main home exclusion changes:
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.
There are some anti- avoidance provisions that will be part of this legislation so care needs to be taken to ensure you qualify for the exemption criteria when making use of this concession.
The rollover relief will apply to disposals of residential land occurring on or after 1 April 2022, even if the original date you acquired the property was before the introduction of the bright-line property rule.
Disclaimer: This article is intended as a general information document only. It is not intended to be tailored taxation advice and should not be relied upon as such. The reader should take their own advice as to their specific situation rather than rely on the contents of this document. The writers accept no responsibility for liability associated with those who rely on this article.