With house prices skyrocketing and first home buyers scrambling for a foothold, the government has released a host of changes that include:
- An extension of the bright-line period from 5 to 10 years
- No interest deduction for residential rental properties purchased on or after 27th March 2021, unless it is a ‘new build’.
- Phasing out interest deductibility for existing rental properties (purchased before 27th March 2021).
The legislation also proposes to alter the ‘main home’ exemption if it has been used for a period of time as an investment and widening the definition of ‘dwelling’ for the tax net to catch buildings that may have otherwise escaped.
The most impactful change for property investors will be the new interest deductibility rules. Unless the property is new, any property acquired on or after 27th March 2021 will not qualify for an interest deduction. Interest deductions for owners of properties acquired before this date will be phased out starting 1 Oct 2021.
This could have a considerable effect on new and existing investments. While all current cash outgoings associated with rental ownership remain, the removal of interest as an available deduction will significantly increase the tax costs for owners using borrowing—a cost that will directly impact your bottom line.
For example, suppose you purchase the median house in Canterbury: three bedrooms, costing $566,000 with a potential rental income of $475 a week. Prior to the rule change, with a full deduction for interest and financed using a 40% deposit, the property may produce an annual taxable income of approximately $5,600. Whereas, under the new rules, the property may instead produce taxable income of approximately $15,700. At the 33% tax rate, this increases your tax expense by $3,300 per annum.
We are eagerly awaiting the exact wording of the law, with many of our questions unanswered. What will the new build exemption apply to? How long is ‘new’ new? Where is the line drawn for interest deductions on short-stay accommodation? How will refinancing be treated?
Although it captured fewer headlines, the extension of the bright-line period from five to ten years will have a profound impact on investors. Houses acquired on or after 27th March 2021 and not used solely as a main home will become taxable if sold within ten years. The capital gain from the sale of a property within the bright-line period will be added to the owner’s taxable income in the year of sale.
New investment property purchases need to be carefully considered, especially with the addition of a new 39% tax rate. Ownership structures have become vitally important, as is evaluating the profitability and cashflow of a potential new venture. These questions and more can be fully canvassed with your director or client manager at Leech & Partners.
