It’s never a dull moment in the investment property world that’s for sure, in recent times property investors have borne the brunt of:
- Increasing Loan to Value thresholds
- Sale of investment property triggering a bright-line capital gains tax (2 years, to 5 years, to 10 years)
- Health Homes Legislation compliance
- Residential Tenancy Act changes
- Ring-fencing of tax losses
- Denial of interest deductibility
All these measures have their place in terms of tinkering with the attractiveness (or increasingly lack thereof of residential property). Now don’t get us wrong, there is merit in any one or combinations of these actions being taken to resolve escalating house prices, but one thing’s for sure, it certainly isn’t landlord friendly.
First thing to note about the changes announced. They do not apply to “new build” investment property. “New Build” has not been defined, although one would have thought that’s reasonably clear cut.
Second thing to note: The following is a summary of the changes and impacts in simple terms (as far as tax language goes) it is not a substitute for specific advice, and we encourage you to contact us if you have a transaction occurring.
Here’s what you need to know
Brightline Test extension from 5 to 10 years for older investment property
The Brightline test applies to the capital gain made from the sale of an investment property for any reason other than death or relationship property settlement. That gain is considered income which is then taxed…… like how a capital gain tax would work.
Effective from March 27th 2021 onward for all residential property purchases (but excluding the home*) this time period extends from 5 years to 10 years that have a binding agreement after that date
Points to note
- Residential Investment Property is impacted EXCEPT “new build” residential investment property (that remains at 5 years)
- Baches, as they always have been, are caught by these rules
- If you have a binding agreement (think unconditional agreement) in place before 27th March 2021 then the purchase will fall under the 5 year rules.
- * Where you reside in your home the whole time, as always, the bright-line test will not apply.
- * For purchases of homes after 27th March 2021 that do get rented there has been a change in that:
- previously the main home exclusion could be obtained where you resided in the property for more than 50% of the timed owned. This is now gone. Instead, a “change of use rule” which will require you to proportionally apply the bright-line test upon a sale occurring where it wasn’t used as the home for 12 months or more in the period of total ownership, the calculation is as follows:
- (Sale Price – Purchase Price – Capital Improvements – Costs of buying * Selling Property) * the % the time it was not used as the owners main home
Impacts of these changes
- As always, but more so now, it is so very important to get the appropriate structures in place before purchase.
- More people will pay more tax on property. This is a bright-line test, beyond relationship property settlements and death, the circumstances for a sale are irrelevant and tax will be paid. Don’t forget that a new 39% tax threshold exists for income over $180,000 which could easily be exceeded if you use the rate of capital appreciation as a benchmark figure for recent years
No Interest Deductibility on old investment properties
For many investors who have leveraged themselves to acquire investment property, the interest expense reflects the largest deductible expense against rental income. Along with the other costs of owning an investment property meant that this significantly reduced the amount of tax otherwise payable and in many situations meant a tax loss from operating the property as an investment property, particularly in the earlier years of owning an investment property. Since 1 April 2019 (2020 tax year) such tax losses have been ring fenced, that is the tax loss is only available to be offset against other investment property profits.
Proposed new legislation to apply from 1 October 2021 will mean:
For property acquired before 27 March 2021
|Tax Year (March balance date)||$ you can claim||Example of tax deduction on $25,000 interest costs at a 33% tax rate|
|2022||100% of interest between April 21 – September 2021|
75% of interest between October 2021 – March 2022
For property acquired on or after 27th March 2021
No deduction for interest costs from 1 October 2021 onwards (April 2021 – September 2021 will be 100% deductible)
Points to note
- Loans used for non-housing business purposes (i.e. business loans, but secured against the home) will not be affected
- Property Developers and their loans for that purpose are not affected as they are paying full tax on their property sales.
- They propose exempting new builds from these interest deductibility restrictions
- They propose that if you are caught by a bright-line test, that interest will be claimable
Impacts of these changes
- There is a real cash cost to landlords that have leveraged investment properties, which could result in:
- They may seek recompense by increasing rents
- They may look to sell leading to an excess of supply of old housing stock
- There will be a surge towards new build investment properties
- A tight construction environment could result in increased prices, reduced quality, or purposely designed property for investment property which isn’t actually that suitable for “first home buyers” so if sold by an investor in the future wouldn’t be a desirable first home purchase, creating a future first home buyer stock issue
These changes are big, and reflect the biggest tax impact to property investors in possibly all of time. This is a politically driven response to a market situation, which to most people appears to need some sort of control. However, these changes bring distortion to investment property purchasing decisions, which we can only assume will result in escalating demand and price in the new build sector, but flattening and quite possibly decreasing the value of older stock.
No doubt these changes will be used as a political football at the next election, so it's quite possible they change in the medium term.
Now more than ever it's important to have a property accountant on your side. P.S. we are property accountants.