Bright-line test extension and interest deduction limitations.

In our recent property seminar, we covered various tax issues, including the bright-line extension and interest deduction limitations on residential investment property.

The bright-line test means if you sell a residential property within a set period after acquiring it, you will be required to pay income tax on any profit made through the property increasing in value.

The Government has extended the bright-line period from 5 to 10 years for residential property acquired from 27 March 2021, except newly built houses (new builds). Inherited properties and those which have been the owner's main home for the entire time they owned it, will continue to be exempt from all bright-line tests.

However, a change to the main home exemption could result in a tax liability if the dwelling has not been your main home for the entire ownership period (although a 12-month buffer applies to allow for shorter-term vacancies such as an OE you undertake, or where you are buying a new family home and the old home has not yet settled when you move).

The main home exemption can apply to family trusts provided certain criteria are met for the principal settlor(s) of the trust. Care needs to be taken involving family arrangements where for example parents are assisting their children to acquire their first home via the parent's family trust.

Interest deductions for residential rental property owned as of 27 March 2021 will be phased out over 4 years. From 1 October 2021, interest deductions will reduce to 75%, and thereafter further reduced by 25% each tax year. From 1 April 2025, no interest deductions will be available.

This limitation does not apply to residential property that is a “new build”. 

The Government has recently released a consultation document regarding various aspects of the legislation and submissions close on 12 July 2021. We have outlined the content of the document below. 

In addition to the relatively new announcements, we also discussed an often-overlooked provision of the Income Tax Act 2007 relating to changes that affect land, such as rezoning changes and resource consents. The Auckland Unitary Plan changes have provided landowners with a potential increase in the value of their land. Where land has been owned for less than 10 years, and 20% or more of the profit on sale relates to the plan change or other such change affecting the land, taxation may arise (subject to residential and farmland exemptions). We recommend obtaining tax advice if you are concerned that this provision may apply to you.

CONSULTATION DOCUMENT ANNOUNCEMENTS INCLUDE:

  • Who will be subject to the interest limitation rules, how they will apply to entities such as companies, and what type of residential properties should be excluded, e.g. employee accommodation;
  • How interest deductions should be determined during the transition phase (the 4-year window where interest will be phased out and tracing rules are proposed), and how to deal with mixed loans where the loans are for a taxable and non-taxable purpose; 
  • Property development and where exemptions should apply to allow for interest deductions to continue;
  • Definition of "new build" and new build exemptions. The Government proposes that a new build will provide interest deductibility and a 5 year bright-line period for what it calls “early owners”, being those that acquire a new build no later than 12 months after its code compliance certificate (CCC) is issued. What then happens if those new builds are on sold? Does the exemption or exception only apply to the first early owner or does it run with the property for its life?;
  • Where property is subject to tax, e.g. a bright-line sale, at what point can interest be deducted, and what is the quantum of that deduction. For example, is an interest deduction available at the point of sale, and what if that creates a loss?
  • Rollover rules and whether the taxing point can be deferred for ownership changes that do not result in a change to the economic owner.

The consultation document is 140+ pages and we are working our way through these proposals. In introducing these changes, the Government’s housing objectives are to:

  • ensure that every New Zealander has a safe, warm, dry, and affordable home to call their own – whether they are renters or owners;
  • support more sustainable house prices, including by dampening investor demand for existing housing stock, which would improve affordability for first-home buyers, and
  • create a housing and urban land market that credibly responds to population growth and changing housing preferences, that is competitive and affordable for renters and homeowners, and is well-planned and well-regulated.

There is more content in this document than initially envisaged, which will add more complexity to tax law. We are not in agreement with the Government on these proposals as the additional complexity they bring is likely to have a converse impact on the Government's intended outcomes noted above.

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Authors

Lisa Murphy
Tax Partner