Residential investor’s hands in the air
Well Tuesday’s announcements certainly increased the workload during the latter part of the week, with numerous concerned investors making contact wanting to know how they were going to be impacted by the proposed changes.
Just in case you were sleeping under a rock all last week and didn’t hear the noise, on Tuesday the Government announced their magic potion recipe, medicine to remedy New Zealand’s residential housing issues, predominantly the struggle for first-home buyers to obtain their first step on the property ladder due to all those naughty speculators out there, whose buying and selling activities are continually inflating residential house prices.
While the Government’s housing package provided some extra support for first home buyers and threw extra funding into a housing acceleration fund and towards Kainga Ora, these announcements were effectively drowned and perhaps forgotten about, by the two big stories of the day, the extension of the bright-line period from five years to ten years, and the removal of interest deductibility for residential property investors – a so called ‘loophole’ in the legislation
The first of these two biggies perhaps was not a surprise for most, as there had been rumours circulating for some time with respect to the current Government’s plan to move to a 10-year bright-line period. However, let us dissect the change a little further, as it was apparent from my discussions with client’s that there is now a lot of confusion as to what the change means in practice:
- Firstly, if you acquired your first interest in your land (basically you entered into a binding agreement to buy the land) prior to 29th March 2018, then the bright-line rules are no longer an issue for you – you were under a two-year bright-line period which has now clearly expired. One point of clarification here, as I have noted the comment being made a number of times, and this point has relevance to any changes to the bright-line periods, including when the rule was first introduced effective 1st October 2015. It is correct that the standard bright-line period for a purchaser of residential land runs from the date of settlement (land title transfer) to the date a binding agreement to sell the land is entered into. However, for the purpose of determining which bright-line period applies to you (none, two-year, five-year, ten-year), it is the date that you first acquired your interest in the land (binding agreement usually) which dictates which rules you are governed by. Once you have determined which rules you are governed by, then you simply apply the standard bright-line period rule (which there are modifications to for certain transactions).
- Secondly, so applying my point of clarification, if you have acquired your first interest in the land post 29th March 2018 and prior to 27th March 2021, then rest assured that you are still only subject to a five-year bright-line period. So as an example, it you signed the sale and purchase (S&P) agreement on 15th February 2021 (conditional or unconditional) with a settlement date of 20th June 2021, a five-year bright-line period applies to you. There is also a carve-out for those who may not have entered into a binding agreement to buy the land pre-27th March 2021, however they had made an offer to purchase the land pre-23rd March 2021, where that purchase offer could not be withdrawn prior to 27th March 2021. A subsequent binding agreement entered into in respect to this offer will be treated as a pre-27th March 2021 first interest in the land, and consequently still subject to a five-year bright-line period.
- Thirdly, if your first interest in the land was not until post-27th March 2021, then whether or not you are subject to the new ten-year bright-line period is going to be determined by whether you have acquired a ‘new build’ – a definition yet to be finalised however suggested to be one where the code of compliance certificate is less than a year old. The definition of a ‘new build’ will be finalised into law post the end of a consultation phase, such amendment retrospective to 27th March 2021. If you are acquiring a ‘new build’, then a five-year bright-line period will continue to apply. For let’s call them ‘second-hand’ purchases, the new ten-year bright-line period will now apply.
- Finally, the ‘main home exclusion’ is changing, but only to those properties acquired post 27th March 2021 (all properties, so including ‘new builds’ still only subject to a five-year bright-line period). Under the rules applying pre-27th March 2021, it’s an all or nothing rule – satisfy both of the 50% criteria and the exclusion applies, miss one criteria and it doesn’t. Under the new rule however, provided the dwelling has been used as your main home since you acquired it, with no periods of non-home use exceeding 12 months at a time, then the main home exclusion will apply. Should you have non-home use exceeding 12 months, then a portion of your bright-line disposal gain will be subject to taxation, even if over the entire time period you owned the dwelling, it was used as your main home for most of the time. For example, you’ve owned the land for eight years in total, and went on an overseas trip for two years during which time the dwelling was rented. Under the previous rule, the bright-line gain would not be taxed (used as main home more than 50% of the time), however under the new rule, 2/8ths of the gain would be taxable.
The second biggie, and without a doubt the one that has caused the biggest stir amongst the investors (as I would suggest it was completely un-signalled to the market beforehand), is the proposal to deny investors a deduction for the interest costs that they incur on their borrowings to acquire a residential investment property, including interest on any borrowings subsequently to make capital improvements to those properties.
So again, let’s take out the scalpel and do some dissecting. Firstly, and most importantly, this change is still only a proposal, it has not yet been legislated for. The proposal will progress through a public consultation period, and if it survives this process, it is proposed to become law effective 1st October 2021. It is proposed…
- That there will be an exemption for ‘new builds’ acquired – not certain yet whether this will include ‘new builds’ acquired pre-27th March 2021, or only those post.
- That interest on borrowings related to property acquired pre-27th March 2021 will be subject to a phase-out rule – 100% deductible to 30th September 2021, 75% deductible to 31st March 2023, 50% deductible to 31st March 2024, 25% deductible to 31st March 2025, 0% deductibility from 1st April 2025. Note however that any borrowings post 27th March 2021 to undertake capital works on these properties will have no interest deduction.
- That those who are eventually subject to bright-line taxation, will be able to claim a one-off lump sum deduction for all interest incurred on the residential property borrowing, when calculating the amount of the disposal gain subject to taxation.
- That property developers and builders will be exempt from the new rules. While there has been mention of the lump sum claim for bright-line taxation, I would suggest a similar lump sum claiming ability for anyone subject to taxation under the various land taxing provisions – remembering that from a legislative pecking order, the bright-line rules only have application where a number of the other land taxing provisions (intention of resale or minor subdivisions for example) do not apply.
The bright-line amendments have already been legislated for, which I will discuss next.
Passing of tax bill, including recently added SOP
The Taxation (Annual Rates for 2020–21, Feasibility Expenditure, and Remedial Matters) Bill, was passed on 24th March 2021, which included a SOP introduced a day earlier to include both the bright-line period amendments and other signalled changes since the draft legislation was introduced. So, what’s now within the law:
- The bright-line period extended to ten years for non ‘new builds’ acquired post 27th March 2021. Note a couple of other amendments to existing rules as well. Firstly, the business premises exclusion in the definition of residential land is amended to ensure that the provision of short-stay accommodation in a dwelling that is not the owner’s home is subject to the bright-line test – applying to property acquired on or after 27 March 2021. Secondly, an amendment to ensure that full-time Airbnb properties, or baches that are sometimes rented out, are subject to the residential deduction ring-fencing rules. For the purposes of the residential rental deduction ring-fencing rules, this proposed amendment will apply for the 2021–22 and later income years, regardless of when the property was acquired.
- The new loss continuity rules, which include now a ‘business continuity test’ – application from 1st April 2020.
- An amendment to the donated trading stock rules for the period 17th March 2020 to 16th March 2022, to turn off the deemed income rule for businesses who make donations of goods for public benefit – particularly during Covid-19 with the likes of food donated to food banks or masks donated to hospitals.
- Introduces purchase price allocation rules to ensure more consistent allocation of the purchase price of property in an asset sale.
- The introduction of a six-year spreading rule for unexpected taxable income that could arise for farmers whose breeding cattle is valued at cost, and has been culled due to the Mycoplasma Bovis outbreak.
- Remedial amendments to some of the increased disclosure rules for trusts and the amendments to the Unclaimed Money Act 1971.
Child support bill now law
A couple of weeks back in AWIR I mentioned that the Child Support Amendment Act 2021 (No 6 of 2021) had been reported back to Parliament. The legislation has since been passed and received the Royal assent on 24th March 2021. Briefly, the new legislation:
- Simplifies the penalty rules.
- Introduces automatic deductions of financial support from source deduction payments made by employers to newly liable parents.
- Introduces a time bar of four years on reassessments of child support for past years.
- Includes interest and dividends in child support assessments for salary and wage earners, and moves from using taxable income to net income which will prevent carried forward tax losses lowering income for child support purposes.
- Makes some technical amendments to assist with the administration of the scheme.
Budget date 2021 announced
Cancel all existing plans to make sure that you do not miss out on this year’s riveting Budget 2021, which will be presented to the House on Thursday 20th May.
This article from the ‘A Week in Review’ newsletter was originally published Monday 29th March 2021. If you have any questions or would like a second opinion on any national or international tax issues, please contact me email@example.com.