Interest Deductibility on Residential Property - Do you have any?

The new Law came into effect on 1 October so we would have expected law by now but in a very Australian like move, we have only got draft legislation introduced as a supplementary order paper to a Bill already before parliament and some information sheets. If you are interested in reading these you can get them from the IRD’s website here.

To start with obviously from 1 October interest deductions will be phased out progressively through to the end of the 2025 tax year for existing residential properties. For properties acquired after 27 March 2021 interest deductions will not be available unless it is a “New Build”. That also means that if you top up existing mortgages post 27 March 2021 interest is not going to be deductible. These changes apply to residential property; in brief that is a property which is suitable for people to live in long term. The main home is not caught because of course that is exempt anyway but there are some interesting new twists on that and obviously commercial property unrelated to the provision of accommodation isn’t affected by these proposals.

Let us start from the perspective of what is/ not residential property and caught / exempt.
• It can include bare land so just be warned.
• the main home is exempt unless owned by a company. Take care with trusts given the principal settlor requirement, especially when parents have assisted children into a home
• Farm land isn’t unless zoned residential
• Emergency, transitional and council housing whether owned by a government authority or even private enterprise is exempt.
• Commercial accommodation such as hotels, motels, hostels are exempt
• Short term accommodation provided in a residential dwelling, AirBnB, BookaBach are not exempt.
• Care facilities, hospitals, nursing homes, hospices, convalescent homes, are exempt.
• Retirement villages and rest homes, employer accommodations, student accommodation and most interestingly land outside of New Zealand are exempt.

Remember these rules are designed to free up supposedly housing in New Zealand so no use denying deductions overseas.

There is an interesting exclusion for certain organisations where residential rentals and land aren’t their core business and form less than 50% of their assets. This exclusion looks generous, but it doesn’t apply to closely held companies. So that is going to be most of our clients. Closely held companies are companies with 5 or fewer natural persons owning 50% or more of the shares

The interest that is denied as a deduction may be available as a deduction when you sell the property if the gains are taxable up to the amount of the gain. Property developers won’t specifically be exempted from the rules, but it is proposed that their development activity will be. So nothing really changes for them, particularly when they are dealing with new properties anyway. If they do retain property to rent residentially then there would likely be the ability to claim the new build exemption anyway.

Let’s look at what is a new build?

Basically, something that gets a new CCC (Code of Compliance Certificate) issued by the relevant council. The exemption that is going to apply, will apply for 20 years to any owner of the property who buys a property on or after 27 March 2020 where the CCC is issued on or after 27 March 2020. Note I said 2020 not 2021. Quite an interesting slip there, I don’t know if that is going to be corrected but at the current time the Government is saying 2020 not 2021 which I find somewhat surprising.
A new build can include modular and relocated houses and it is possible to convert an existing dwelling into multiple new dwellings and this will qualify as a new build. So too can a commercial building that is converted into residential. In brief anything that basically gets a new CCC as a residential dwelling will be eligible for the new build 20-year exemption. What this means is if you buy it and own it within that 20-year window, no matter how many people before you, interest will be fully deductible subject up to the point of the income because of the rental loss limitation rules applying as well. When buying residential rentals, therefore, look at when it had its CCC issued.

These are only proposed changes and the concern here is that it is going to sit as a Bill and a supplementary order paper with the finance and expenditure select committee for probably 6-8 weeks and maybe a bit longer with the COVID lockdown at the moment. So the reality is that these rules likely will get fine-tuned further. My advice to you is just to be careful and make sure you check back each time with the relevant law and particularly at least the information sheets in the meanwhile. It is important that you check because there are some confusing points, particularly when you line up the interest deductibility provisions against the changes to Brightline rules.

In my opinion not having the definitive law in place is poor governance. The prospect of tinkering with what is proposed will also lead to traps for the unwary but at least there is now some understanding of what is happening.