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It is not a loophole

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Let’s start with clarifying something. The fact residential landlords have been able to claim a tax deduction for mortgage interest is not a ‘loophole’. A fundamental principle of New Zealand’s tax system is that a person’s tax liability is calculated based on their profit. This is a function of gross rent received, minus expenses, i.e. rates, insurance and interest. The same principle applies broadly to our tax system in its entirety. I can hear a few people saying, but capital gains are not taxed and that is profit. Yes, that’s true. But until an elected Government introduces a capital gains tax (and stays in power to get it passed) we do not tax capital amounts.

There’s no denying that housing affordability in New Zealand is a significant issue, with the housing market in New Zealand becoming the least affordable in the OECD. In the month of February alone the median house price increased by $50,000 according to REINZ. When the Government was elected, it said it would address the housing crisis without introducing any additional taxes.

But now under the Government’s recent housing policy announcement, interest payments on residential rental properties acquired on or after March 27, 2021 will no longer be deductible. Interest incurred on debt relating to properties acquired before March 27, 2021 will be phased out from October 1, 2021. Over the next four years, interest deductions will decrease by 25 percent each year until the 2025-26 income year when interest payments will become non-deductible. New builds will be excluded from the new non-deduction rule; however the detail is yet to be determined. But one can foresee a scenario in which investors will favour new builds and given the lack of supply, this is likely to fuel prices even more. Especially if old stock is sold to purchase new to retain interest deductions, which could then reduce the price of old stock.

Changes are also being made to the bright line test which taxes the sale of residential property within a prescribed time frame, excluding the main home. Currently the bright line period is five years, having been previously increased from two years since its introduction in 2015. The Government announced that the bright line test will be increased from five years to 10 years for residential properties purchased after March 27, 2021. However, the existing five year period will continue to apply for new builds.

The exclusion for the “main home” has been applied on an all or nothing basis until now. If the property was “predominantly” a main home for the period of ownership it is not taxable on sale. This is also being amended.  For residential properties purchased after March 27, 2021, a sale will be taxable to the extent it is not used as the owner’s main home for more than 12 months at a time. If the property was purchased before March 27, 2021 the main home exclusion continues to apply on an all or nothing basis.

Consultation will also be completed on whether interest that was denied could be claimed if the sale of the property is taxable on sale due to application of the bright line provision.

I think we can all acknowledge that the house price increases we have seen recently are unsustainable and put the sector at risk. But most people agree it is a product of a lack of supply and the cheap cost of debt. Denying interest deductions, thereby increasing the cost of debt, whilst also artificially favouring new builds may help supply. But this is not the first time policies have been implemented to curb house price inflation. To date, depreciation deductions have been denied, rental losses ring fenced, the bright line test was introduced and then increased from two years to five, and yet prices continued to increase.

Let’s hope that the Government’s supply side measures gain momentum and that the rampant property price inflation we are seeing is suppressed by more housing coming available for New Zealanders.

The comments in this article of a general nature and should not be relied on for specific cases. Taxpayers should seek specific advice.

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Hayden Farrow

Hayden Farrow is A Partner and tax at PWC Hamilton based in the Waikato office. Email: hayden.d.farrow@nz.pwc.com

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