Despite recent reductions in property prices, there is little doubt that the passion New Zealanders have for investing in residential property will survive. However, the tax treatment of residential rental investments has increasingly become a tangled web of complexity due to changes in legislation over the past few years.
It used to be that ‘mum and dad’ would setup a look through company, purchase the property, all expenses would be claimed (including interest and depreciation) and the loss would offset against other income and be ‘exchanged’ for a tax refund. Years down the track when the property was sold, the profit was a non-taxable capital gain. Simple.
Roll forward to today and:
- Excess tax losses are ‘ring-fenced’, carried forward, able to be offset against future rental income and offset against taxable income arising from the disposal of a residential property.
- Depreciation is no longer able to be claimed on residential rental properties, even though it was re-introduced for commercial properties.
- Interest on debt incurred to purchase a residential rental property prior to 27 March 2021 is currently being phased out. If a property is purchased on or after 27 March 2021, interest is non-deductible from 1 October 2021. However, if the property qualifies as a new build, interest remains deductible. The cost of increasing interest rates is being exacerbated by this change because a tax deduction would have otherwise been able to be claimed.
- Finally, the ‘capital gain’ on sale may also be taxed under the brightline rule. This itself has been extended from an initial 2 year period, to 5 years and is now 10 years, while new builds remain under a 5 year period. This creates the need to not only examine the date of acquisition and sale to quantify the ownership period, but also work out which bright line period actually applies.
- Where a taxable loss on disposal is incurred within an applicable brightline period, it must be carried forward and can only be offset against income from future taxable land disposals.
A cynical person might suggest the next change will be to prohibit a deduction for accounting and legal fees incurred to navigate the rules.
The changes have altered the residential property landscape, placing residential properties into their own category by virtue of their tax treatment. It is now common for landlords to have an income tax liability, even though the property has not made a profit.
Whether these changes have fed into the current challenges facing the residential construction sector is unclear, but it is unlikely that they have helped