OPINION: Property Investment Tax Changes. What Are Your Options?
Written by Brendan Waters, Director, Edge Advisory, BrendanW@edgeadvisory.nz
Being a residential landlord has always been one of the favourite Kiwi forms of investment. Historically it has provided a good long-term return on investment and has also played a big part in providing housing to those who need or choose to rent.
New rules have been put in place over the past few years that have made the tax effectiveness of being a landlord less attractive. The main ones being the introduction of the Brightline rules that tax some capital gains, the ring fencing of residential rental losses, and the changes to interest deductibility.
Whilst I understand what these rules were put in place to do, from what I am seeing I am not sure the intended outcomes are being achieved. Those very people that these rules were designed to assist and protect are now often facing increased rents.
The introduction of the Brightline rules that can tax capital gains on a secondary property and the ring fencing of residential rental losses have been well documented and are largely understood. However, the changes to the interest deductibility rules are not so well understood. Therefore I have focused specifically on outlining these rules and some strategies to consider.
High level, from the 2022 tax year there will be a reduction in the ability to claim mortgage interest for residential investment property. These rules do not apply to property developments and new builds (subject to certain rules). Each year, the percentage of interest you can claim will decrease until March 2025, at which point you will not be able to claim any further interest deductibility. Let’s take for example a landlord that has a mortgage of $500,000 from April 2025. This will mean you will no longer be able to claim the $25,000 interest expense against your rental income. For someone on a marginal tax rate of 33%, that could have a tax impact of up to $8,250, which will need to be covered from after tax earnings.
I won’t bore you with the tax technical detail. Let’s focus on what this actually means for landlords and some things you could consider as part of your investment strategy. The IRD have provided a good summary in the attached link Changes to Property Tax
What we are typically seeing from our landlord clients are one of the following strategies or variants of:
- Sell the property.
When these rules first came out, it was expected that a number of landlords would sell up given the raft of changes impacting residential landlords. However, I have not seen any evidence of a material increase in sales activity to date from my clients as a direct result of these changes.
- Do nothing.
Some landlords are happy with the tenants they have in place and are not comfortable with increasing rents in the current environment. They might be in a position where they can afford to (or they choose) to wear the impact of the tax changes. In addition, a number of landlords have accumulated ring fenced losses that mean the impact of these changes may not be felt for a number of years.
- Rent reviews.
Under the Residential Tenancies Act 1986 you are only able to increase rent every 12 months. As such, you should firstly look at when you last reviewed the rent. Some things you should consider is how close are you to market rental? What is the demand for rental properties in your area? How good are you tenants? What is the tax impact on the interest deductibility changes? Can you start to bridge the gap of lost tax concessions through an annual increase to the rent?
- New builds.
These rules were implemented in part to encourage the building of new residential homes. As above, it is important that you understand the cashflow impact of the rule changes. For some landlords it might be a good time to crystalise gains they may have made and look to reinvest through a new build rental property. We have some clients who have chosen to subdivide and build a new residential rental. If it meets the definition of a new build, you can take a 100% interest deduction on interest for loans to purchase and/or build that rental. For those who choose to sell an existing rental and purchase a new build, you need to consider costs associated with the sale of existing properties e.g. legal fees, real estate commissions, Brightline/income tax etc.
Landlords considering adding to their residential rental portfolio will need to assess whether they are better to purchase a new build or an existing property. There are certainly tax incentives through interest deducibility for a new build, however there may be opportunities with a ‘second hand’ property to subdivide and add a second rental, to add additional rooms etc. So while you need to consider the tax implications of your decision, there are other commercial considerations as well.
Whatever options you are considering, it is important you seek assistance from your Accountant/Adviser to fully understand the tax implications. This is also where Property Managers can add considerable value, as they understand the rental market and are best placed to provide you with the information and guidance you will need to assess your best option.
