In March 2021 the Government announced changes to the bright-line test and interest deductibility for residential properties.
Following the release of a discussion document in June, there has still been significant uncertainty regarding the specific details of how the new rules will apply. However, the government has now provided clarity through the release of draft legislation on 28 September 2021. For the purposes of the legislation, a new term has been coined – “disallowed residential property” (DRP), which refers to those properties for which interest deductibility will be affected.
DRP’s purchased before 27 March 2021 will have their interest deductibility phased out between 1 October 2021 and 31 March 2025, while those purchased on or after 27 March 2021 will be wholly denied the deduction from 1 October 2021. However, if a property has had a code compliance certificate (CCC) issued on or after 27 March 2020 it will qualify as a ‘new build’, in which case interest will remain deductible.
The date of 27 March 2020 is one year earlier than expected. Properties that qualify as social, emergency, transitional or council housing will be excluded from the interest limitation rules, regardless of their new build status. It is also proposed that if interest is treated as non-deductible, but the property is sold and the sale is taxable under the brightline test, then the previously denied interest deductions are able to be claimed as a cost thereby reducing the taxable profit on sale.
A key question in recent months has been how long interest deductions will last for new builds.
As per the draft legislation, interest on new builds will remain deductible for 20 years from the issue date of the CCC. Furthermore, interest will remain deductible for subsequent owners throughout the 20-year period, abandoning the potential requirement of being an ‘early owner’ outlined in the June discussion document. A previous amendment extended the bright line period to 10 years for residential property acquired on or after 27 March 2021. However, new builds purchased on or after 27 March 2021 (one year later than the relevant date above for interest deductibility) remain subject to a 5-year bright line period.
Unlike the interest exemption for new builds, the new build bright line period of 5 years does not apply to owners that purchase the new build more than 12 months after the CCC has been issued. Therefore, in general, subsequent owners will not get the benefit of the shorter 5 year period. In a welcome and unexpected development, limited rollover relief for certain transfers to trusts, LTC’s, partnerships and individuals will be introduced. This will allow property transfers to take place without triggering the bright-line test where there is no economic change of ownership.
The above is a summary of the key features of the legislation. However, the legislation itself is a lot more complicated due to the large number of varied situations and permutations that must be catered for in practice.
Despite the answers the draft legislation has brought us, it is apparent that navigating the rules (both new and old) will prove complicated and fraught with risk.