The tax battle: Property Investor vs. First-Home Buyer?

The Government’s latest announcement regarding changes to legislation in response to soaring house prices will affect existing and future property investors as well as the first-home buyer.  It is clear the government are making the ownership of rental properties less attractive with use of the taxation system.  The potential impact being the exit by these investors and in turn providing housing stock that would be available for First-Home buyers to then purchase.

The removal of interest deductibility will have a significant impact on both the return on investment and free cash flow from investment properties with a high level of borrowing.  There is already the impact of ring fencing of residential rental losses being felt by investors, this however, is a significant deviation from the long established concept of being able to deduct interest costs where the borrowing relates to earning income.

The extension of the bright-line was widely expected; many picked ten years was the next logical step for increasing the proportion of property caught in what is essentially a capital gains tax.  This will have an impact beyond just investment properties. In particular, some lifestyle properties and holiday homes will become subject to tax if sold within a ten year period and a gain is made. 

Less expected was the inclusion of a change-of-use rule for the bright-line test.  This means that if the property is not used as a main home for a period longer than 12 months it would be subject to tax for the proportion of time not used as a main home if sold within the bright line period and a gain is made.

The Government’s detailed announcements are as follows:

  1. Bright-line test extended to 10 years which means that people who buy and sell investment property within 10 years will need to pay income tax on any gains made from the sale.

The Bright-line test looks at whether the property was either:

  • Purchased on or after 1 October 2015 through to 28 March 2018 and sold within 2 years
  • Purchased on or after 29 March 2018 and sold within 5 years
  • Purchased on or after 27 March 2021 and sold within 10 years

The family home and any inherited property will continue to be exempt from the bright-line test, and the bright-line test for new build investment properties will remain at 5 years.

  1. Interest deductibility on investment property removed, therefore property investors will no longer be able to deduct the interest on the loans used to purchase the property from their rental income as an expense.

The legislation will apply from 1 October 2021.

Interest deductions on residential properties purchased on or after 27 March 2021 will not be allowed from 1 October 2021.

Note that interest on loans for properties purchased before 27 March 2021 will remain deductible but the amount you will be able to claim will be reduced over the next 4 years. At the end of the 4 year period none of the interest on the loan will be deductible for income tax purposes.  There would however, be an exemption for newly built homes.

  1. $3.8 billion Housing Acceleration Fund set aside to aid the funding of infrastructure around housing developments.
  2. Price and income caps raised for the Government’s First Home Grants and First Home Loan which means that more first-home buyers will be eligible for the existing First Home Grant and First Home Loan.
  3. The Government will also help Kainga Ora to borrow an additional $2 billion to aid in strategic land purchases to enable the building more affordable state housing.

It is disappointing to see the continued use of tax measures to try to control house prices resulting in different taxation outcomes within a group taxpayers.

The risk of creating distortions in investment decisions and the unintended consequences are high when taxation is used as a lever.  Each business owner and/or investor will have a range of structures and operating models.  When tax policy is targeted at a desired outcome, this is likely to create unexpected results for different taxpayers depending on their particular situation.

As with any tax change, the devil is in the detail and the impacts of these changes will become better known over time.  If you would like to discuss your particular situation and review how these changes may affect you and your business, please contact our office to discuss further.

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