In March, the Government announced the residential bright-line test will increase from five to 10 years and interest deductions for residential property will be phased out.
The changes are intended to dampen house price inflation and are aimed at residential investors.
However, it was also announced that ‘new builds’ would be exempt from the above changes, yet no detail of what comprises a new build was provided. This has left the housing market in a state of uncertainty which has impacted new home builders.
On 10 June, IRD took the next step in the implementation process with the release of a discussion document titled “Design of the interest limitation rule and additional bright-line rules”. The document provides a sense of what the new build definition is likely to comprise, but also seeks feedback on a large number of complex scenarios.
As a general signpost, the Government considers that property should only qualify as a new build where residential housing supply has increased.
There are two parts to the new build exemption: what physically comprises a new build and who the new build exemption can apply to.
It is proposed that to comprise a new build, the dwelling must have a code compliance certificate (CCC) issued on or after 27 March 2021. There is an exception for certain builds with a CCC issued before this date, provided the build is acquired on or after 27 March 2021 and no later than 12 months after it received its CCC.
There are three categories under which new builds can fall: simple new builds, complex new builds and commercial to residential conversions.
A simple new build involves adding one or more self-contained dwellings to bare residential land. The home can be fully or partially constructed on-site, capturing modular homes and dwellings that have been relocated onto the land. Replacing existing dwellings with one or more dwellings is also acceptable. Of course, a one for one replacement would contradict the G overnment’s ‘increase housing supply’ mantra, but a concession has been made in order to reduce the administrative costs necessary to enforce this. A complex new build involves adding one or more self-contained dwellings to residential land that already has an existing dwelling on it, without separate title being issued for the new build portion of the land. This includes adding standalone dwellings, attaching new dwellings into existing dwellings and splitting existing dwellings into multiple dwellings.
The final category is commercial to residential conversions. For example, an office building being converted into apartments.
Renovations that do not clearly increase housing supply are excluded, such as adding a new room to an existing dwelling or updating a kitchen. The G overnment proposes that differentiating between simple renovations and reinvigorating an uninhabitable dwelling would be too difficult. Consequently, they elected to exclude such properties from the ‘new-build’ definition. This seems unnecessarily dismissive, a point which the Government concedes; therefore they are inviting feedback on how to verify a once uninhabitable house has been renovated to become habitable.
In terms of who can then take advantage of the ‘new build’ exemptions, the Government proposes that you must be an ‘early owner’. An early owner is someone who acquires a new build either before the CCC is issued or no later than 12 months after the CCC is issued. As to how long the exemption will apply and whether it will apply to subsequent owners as well is still up for discussion. For early owners, it is likely to either apply in perpetuity or for a fixed period. However, for subsequent purchasers it will likely apply for a fixed period, if at all. Further consultation will be taken before a decision is reached.
The Government is also inviting discussion on whether a property will cease to qualify for the new build exemption once it has been lived in by an owner-occupier. If this is implemented, only new builds that have been used exclusively as a rental property will be eligible for the exemption.
The approach to the bright-line test for new builds is slightly different in that it will only remain at five years for early owners that purchase new builds on or after 27 March 2021, and is not expected to apply to subsequent owners. Depending on the final form of the rules, this could lead to cases where owners are eligible for interest deductions but are not eligible for the five year bright-line period. Interestingly, the five year period for new builds may continue to apply to residential land with a new build on it regardless of whether it’s rented; allowing second homes and baches to benefit as well.
The Government is yet to decide on certain topics, such as whether past interest expenditure that was non-deductible under these changes could be treated as deductible if the property’s sale is taxable.
While this discussion document provides some clarity to the topic, it also introduces a web of legislative complexity. The Government is willing to make concessions in the name of reducing ‘administrative’ burden and acknowledges it doesn’t have all the answers.
Ordinarily, tax legislation increases in complexity relative to the transactions it applies to; yet here, we are seeing complex legislation being applied to common place transactions. This increases the risk of people getting it wrong and finding themselves on the wrong side of an IRD ‘knock on the door’.
The comments in this article are of a general nature and should not be relied on for specific cases. Taxpayers should seek specific advice.
