While we're still trying to get our heads around recent changes to the Residential Tenancies Act, the Government has announced extreme new measures to tackle the housing crisis.
To tip the balance of power in the market away from speculators and more towards first home buyers, the Government has decided to extend the bright-line test to 10 years and altogether remove interest tax deductions on rental properties.
The changes also include $3.8bn for infrastructure development to accelerate house building; the lift of income caps on First-Home Grants and Loans; $2 bn loan to Kāinga Ora to scale up land acquisition; and the extension on the Apprenticeship Boost scheme to help grow construction workforce.
Why Is This Happening?
The Housing package is designed to fix the "broken" housing market by increasing the supply of houses and putting some controls in place on the unsustainable growth rate of house prices (removing interest deductions for investors and extending the bright-line test). These measures are designed to discourage speculators and to make property affordable again for first-home buyers.
The Government has passed the new bright-line test rules this week under urgency. The investors will now be taxed on any capital gains if the residential property is sold within 10 years.
This rule excludes main homes and (in most cases) inherited properties.
The new plan will keep the bright-line test for new builds at five years.
This has already passed via a Bill
For many property investors, that tax rate could be about 33 per cent or 39 per cent of the sale, depending on their income and how much the house is sold for.
Any investment property with a settlement date after March 27 2021, will be hit by the new rules. If a property purchased is brand new, you will be taxed on any gains if it was resold within 5 years. If the property purchased is an existing home, you will be taxed if it was resolved within 10 years.
Here is a table that explains how these rules will affect you:
Another change in the bright-line test rules around the treatment of the main home exemption. Currently, if the property is used as the main home for more than 50% of the time, then it is completely exempt from taxation. If it’s 49% and under it’s going to be fully taxable.
The new proposal is to change that for property acquired on or after 27 March – you’ll be taxed on the period it was not occupied as your main residence. So, if it was the main home for 80% of the time, then 20% of the gain will be taxed.
Interest Payments Tax Deductions
The most surprising change was the Government's decision to completely eliminate interest rate tax deductions, which investors can currently claim on properties. This means investors can't offset the cost of the interest they pay on their mortgage against their tax bill. The policy is not dissimilar to the one introduced in the UK earlier.
This change will take effect from October 1 2021, for properties bought after March 27. For properties purchased before that date, deductibility will be phased out over the next four years.
Suppose the property was acquired before March 27 2021. In that case, the landlords could still claim interest (for existing loans) as an expense against residential property income. Still, the amount landlords can claim will be reduced by 25% each income year until completely phased-out from the 2025–26 income year.
The new law will come in from October 1.
The Government may exempt new builds.
These changes won't apply to loans for non-housing business purposes.
Property developers and builders will also not be affected by this rule change.
If money is borrowed on or after March 27 to maintain or improve the property bought before March 27, it will be treated the same as a loan for a property acquired on or after then.
Limit Rent Increase
It feels like only yesterday, the law restricting rent increases to once per year has been introduced. The Government is now proposing to limit rent increases to once every 12 months per rental property (not tenancy). This means that if you were to re-let the property to new tenants, you would be restricted to lift the price up if there have not been 12 months since the last rent increase.
This change is still in consultation.
Possible Consequences And Other Possible Changes
The landlords are still coming to terms with the recent Healthy Homes Standards and The Residential Tenancies Act changes. But things are about to get harder.
The Bright-line extension was not altogether unexpected and impacts more property speculators rather than traditional residential landlords who view the property as a long-term investment.
On the other hand, the removal of interest deductibility came as a big surprise. The cost of the mortgage is the biggest single cost for landlords. Removing interest deductions could hit property investors hard.
If the interest tax deduction is not permitted, the interest costs are no longer tax-deductible. This will make some rental properties significantly more profitable, and in many cases, push property investors to another tax bracket, meaning they will have a lot more tax to pay. Alternatively, this may make some already low cash flow positive properties, loss-making ones, making them less appealing investments.
In the short-term, with changes being phased-in over several years and interest rates at an all-time low, the property investors with existing properties may not feel the full effect of the proposed changes. But the changes are likely to have a significant impact on investor's cash flow in the long-run. Scrapping the interest deductibility will add a considerable amount to the cost of providing rental property. This will discourage new investors from coming into the market and/or build their portfolios. Some existing residential landlords might struggle to hold lower cashflow properties or properties with high mortgages.
Without interest deductions, investors will need to see a higher return rate to justify their property investment. This may lead to higher rents (although they will be restricted by the tenant's ability to pay)
The Government is still considering further changes - removal of interest-only loans on investment properties, the introduction of debt to income caps, rent controls, and allowing interest deductibility for new builds. These will be reviewed in May this year.
By the next election in 2023, it will be clearer if these changes are working and helping to address the housing crisis. But if the rules are not working, the Opposition may use this as an opportunity to have their say and propose scraping them.
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