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Peter Taylor: What the removal of interest deductibility on residential rental properties means for New Zealanders

The government has removed the interest deductibility on residential rental to tackle high house prices and housing affordability. The changes in interest deductibility will, however, have a significant impact on many New Zealanders with increases in rent, resulting in a decrease in housing affordability and savings for retirement.

With the phased removal of interest deductions for residential property purchased on or after 27 March 2021 against income derived from residential rental properties, it will be harder for landlords to cover mortgage repayments and discourage them from investing in residential properties. There are some attempts to address this with interest being allowed on new builds and the provision of social housing and rent-to-own to encourage investment in this area. Will it be enough? It is definitely an interesting experiment!

The change in interest deductibility which will progressively be phased out is a concern for many landlords as it increases the amount of tax owed each year and investors will need to pay for the interest costs incurred out of income that they have already paid tax on. An unintended consequence is that existing landlords that choose to stay in the market will review rentals to cover the increased costs of ownership for the lost interest claim. This means rents will rise further in an already inflationary stage of the cycle, and worsen rental affordability even further.

The only exemptions which investors may take advantage of now are the new build exemptions which can also be applied to purpose-built rentals and also social housing. As unattractive as these options may be, they allow investors to “pivot” their investments towards these areas and potentially sell down part of their portfolio so they can remain an investor without facing crippling tax costs.

I consider these interest deductibility changes a breach of a pre-election promise by the current government to not increase taxes on rental investors. The interest deductibility changes will decrease a rental property’s income-earning capacity and will make rentals less attractive, further exacerbating supplies of rental availability, supply and costs to those looking to rent. Hopefully, there may be a softening in the hard-line taken by the government in favour of a partnership approach.

Whether you should pivot away from your existing residential rental property to other investments, such as new builds/ social housing requires other non-tax considerations, such as whether the yield on a new build makes such an investment viable, whether the increased risks from leasing property to social housing providers is justified and whether your bank would support loans on the investment and/or offer standard residential lending rates and the usual LVR percentage applicable to residential lending.

Another consideration is whether a repeal of these rules is likely if there is a change in Government and if so, whether selling up now may be premature, or you can “wait” it out for the next couple of years (particularly, if they still qualify for some interest deductions under the transitional rules), given the residential property market appears to be softening at the moment due to increased lending restrictions and requirements which have been imposed on the banks.

If you sell up, then we note that the decision to sell a residential rental property to invest in something else please ensure you are not caught by the bright-line test and taxed on the proceeds. The buy and sell dates applied by the IRD have caught a number of people out and unexpected tax costs have resulted.

Finally, if you use the equity in existing rentals to borrow additional amounts, whether interest on these additional amounts is deductible will depend on what the borrowings have been applied to, rather than the fact that the borrowing is ‘on’ the rental property. For example, if you use the equity in existing rentals to borrow additional amounts to do up the family home, interest on the additional borrowings is non-deductible, as the borrowing was for a private/ domestic purpose. 

Feel free to contact me at any time should you need assistance with any of the matters raised. Any restructuring of debt or pivoting your investments without expert assistance could incur additional tax costs and penalties.

Peter Taylor, CA, CPP, MBA

Peter is the director of BDS Chartered Accountants.

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