Bright-line test extended and interest deductions scrapped for investors

March 23, 2021

Nexia bright-line announcement

In a move to crack down on property speculators and to make housing more affordable for first home buyers, the Government has today unveiled a number of property announcements:

  • Extension of the bright-line test from five to 10 years
  • Removal of interest deductions for investors
  • Increased income caps and higher house price caps for the First Home Grants and Loans
  • $3.8 billion fund to accelerate housing supply
  • Support to Kāinga Ora to borrow an additional $2 billion for land acquisition
  • Apprenticeship Boost initiative extended to further support trades and trades training


Our Tax Director Maggie Jaques examines what these changes mean.

Bright-line test

In a widely speculated move, the Government has doubled the bright-line test from five to ten years for investment property acquired on or after 27 March 2021. 

A word of caution on when land is “acquired” for these purposes – effectively any binding contracts entered into on or after 27 March 2021 (this Saturday) will be subject to the new bright-line test.  A binding contract can include one which is subject to conditions, such as finance or title being issued.

However, if your contract is for a new build then a five-year bright-line test will apply.  Further work will be done to define exactly what a new build is, but it is anticipated to be a property that is acquired within a year of receiving its code of compliance.


Main home exemption

The sting in the tail of the extension of the bright-line test is the proposed change to the main home exemption.  If you acquire land (including your main home) on or after 27 March 2021, then you are by default subject to the new 10-year bright-line test, or the new five-year bright-line test for new builds.

Well, that’s fine because it is going to be used as my main home you may be thinking. However, be warned that you are now subject to a new main home exemption.  The existing main home exemption is an all or nothing test – so if it is your main home for at least half the time you own it, then it applies.

The new main home exemption test will work differently. Now, if you have periods of 12 months or more where it isn’t your main home, then you will need to account for tax on a proportion of the capital gain derived.

So, if you own a property for eight years, use it as your main home for five years and rent it out for three years, then you will have to account for tax on 3/8ths of the capital gain.  Say you buy a property for $1 million and its worth $2 million when you sell it, you’ll be liable for tax on $375,000 (being 3/8ths of the $1 million gain).

This rule doesn’t allow a market value uplift for the “cost” of the land at the time you stopped using it as your main home.  Instead, it taxes a proportion of the capital gain derived over the entire period of ownership.


Interest deductions scrapped

As a means of dampening demand, the Government is proposing to:

  • Deny interest deductions for residential rental properties from 1 October 2021, where those rental properties were acquired on or after 27 March 2021
  • For rental properties acquired prior to 27 March 2021, interest deductions will be successively denied over a four-year period

 Income year

Percentage of interest deduction allowed

 2021

100%

 2022

6 months to 30 September 2021 – 100%

6 months to 31 March 2022 – 75%

 2023

75%

 2024

50%

 2025

25%

 2026

0%


Similar to the bright-line test, property is acquired when a binding contract is entered into and this Saturday is the key date. Note that the interest limitations apply only to residential rental properties, so these rules won’t apply to commercial rentals or property dealers and developers who are subject to tax on their land sales.

There is no doubt that removing interest deductions on residential rental properties will hurt both investors and tenants. The argument for removing depreciation deductions on rental properties in 2011 was that depreciation wasn’t a cash cost and didn’t represent a true economic loss. The situation with interest on a mortgage could not be more different; interest must be physically paid and the cash must be found from somewhere. 

If investors are no longer able to deduct their interest costs, they are likely to find themselves in a position of having to pay tax on income that bears no resemblance to the actual return on investment.  The inevitable increase in costs is likely to equate to an increase in rents for tenants.

Home ownership is only one aspect of the housing crisis; a steady supply of affordable rentals is another necessary part of the puzzle and this move by Government will worsen the situation.  The change also begs the question as to why it is necessary to remove interest deductions when we already have residential ring fencing for losses; surely excessive interest deductions would be appropriately handled by these existing rules, without requiring a separate limitation on interest deductions?

Capital Gains Tax

The proposals come at the same time as an increase in the top marginal tax rate for individuals from 33% to 39%.  It wouldn’t take a significant bright-line gain, along with a salary, for a property captured under the bright-line test to be taxed at 39%.  Given that we will now be dealing with a 10-year period, we are likely to see a significant increase in people retaining their properties for longer (and thereby adding to the shortage of land available for sale) and for those who have no option but to sell, a tax on capital gains at 39%. 

It is interesting to observe that our Prime Minister rejected a comprehensive capital gains tax regime outright, presumably due to the impact of such a regime on voters, yet we now find ourselves in a situation of a potential 39% tax on capital gains over a 10-year period, reduced availability of the main home exemption, and a removal of interest deductions. 

It remains to be seen whether the tax changes will have any impact on the housing crisis. Unfortunately similar moves by other countries have done nothing to dampen demand (the Sydney housing market for example). There is no doubt that increasing the supply of housing will have a real impact, but progress in this area has been lacking by our current Government. Let’s hope that some of the other announcements made today will have an impact on the supply side of the equation.

Please contact our tax team if you would like any assistance in reviewing how the Government’s announcements may impact your situation.

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