The Three Gremlins

In the past, there was a point in time when homeowners would hold enough equity in their personal house to allow them to borrow from their bank 100% of the funds to purchase a second property. This second property was rented out with rental income going to pay for property expenses such as rates, insurance and so on together with the mortgage interest and loan repayments. Invariably, the rental income was insufficient to cover all of the costs so the property would run at a loss. This loss was often structured in such a way as to be offset against the householder with the highest income — to maximise an annual tax refund. After a period of time, the property was often sold at a considerable gain. This gain was deemed to be non-taxable due to the taxpayer’s intention at the time of purchasing the property to generate income and not derive a capital gain from the sale. This arrangement prevailed for many years and was viewed by the IRD as a one-way street in favour of the taxpayer. 

As you could imagine no one ever brought a property to resell it and pay tax on the gain.  Annual tax losses were always structured in such a way for maximum tax benefits.  The first major change came with the introduction of the BrightLine test rules on the 1st October 2015. It started off with a 2-year minimum hold time, but this time span has moved twice from 2 to 5 years on the 29th March 2018 and more recently, from 5 to 10 years for property purchased post 27th March 2021. The focus of the Brightline rule is to tax the gain on any profits from the sale of property that is not your main family home. Of interest to myself and where taxpayers commonly misinterpret this rule is centred on the main family home exemption. This needs to be the place where you are living to qualify for the exemption. A bare section with a set of plans drawn up for a family home to be built in the future doesn’t qualify when the on-sale of the bare section is remade.

From the start of the 2020 tax year, residential tax losses were prevented from being claimed against other income sources. This rule known as “Residential ring fencing” has had quite an impact on the refunds some taxpayers were receiving annually. These losses can still be offset against future residential rental income and in some situations, against Brightline profits but not other income. 

How residential income is calculated has changed for the 2022 financial year with the phasing out of interest claims on property purchased pre 27th March 2021. No claim for interest is allowable on property purchased after this date. The only exception is for “new builds” which will gain a 20-year period of allowing interest deductions. For the phasing out, only 75% of the interest will be deductible from 1st October 2021. Next year (2023), only 50% of the interest will be allowed as a deduction and will move to 25% for the 2024 year, and then to 0% for the 2025 tax year.

In summary, the taxation rules around residential property have become complex and in comparison to the past rules, provide limited benefits to taxpayers.