The article explores the intricacies of interest deductibility changes in New Zealand, particularly in the context of the transition from Labour’s policy to National’s proposed alterations. Key points covered include the impact on property investors’ tax bills, exemptions for certain property types, and illustrative examples demonstrating the financial implications for investors under National’s policy.
Back in 2021, the Labour government in New Zealand introduced significant changes to tax laws, commonly known as “interest deductibility.” These changes aimed to increase taxes for property investors, impacting their taxable profit. However, with the National party winning the 2023 election, promises were made to slowly reverse these changes. We explore what the changes to interest deductibility mean for investors, how they have evolved, and what to expect in the coming years.
Interest Deductibility Changes: Pre-October 2021 and Post-Labour’s Policy
Before October 2021, property investors calculated their taxable profit by subtracting operating expenses and interest costs from their rental income. The result was then multiplied by the applicable tax rate. However, Labour’s changes eliminated the deduction of interest costs, leading to increased taxes for property owners. These changes affected different properties in various ways, with exemptions for New Builds and houses rented as social housing.
National’s Reinstatement of Deductibility Plan and Its Impact
With National winning the election, they plan to gradually reverse Labour’s policy, aiming to fully reinstate interest deductibility by 2026. While this is positive news for property investors on their investment properties, the details of implementation remain uncertain as National has not formalized its action plan. Investors should stay informed as discussions around interest deductibility are likely to persist until at least 2026.
Tax Implications Based on Purchase Date
Labour’s changes created two classes of properties based on purchase date – before and after March 27, 2021. Those who bought before faced gradually increasing taxes, while those purchasing after, faced higher taxes immediately. National’s proposed changes aim to treat all properties uniformly, likely taking effect in April 2024.
Tax Exemptions and Opportunities
Certain property types continue to enjoy exemptions or tax benefits. New Builds, social housing, relocatable homes, multi-tenancy conversions, boarding establishments, and student accommodations with tertiary agreements are among those exempt from the new tax rules. Understanding these exemptions can significantly impact an investor’s tax position.
Comparing National’s Policy: Cash Flow Benefits for Investors
National’s proposed changes are expected to reduce taxes for many property investors, improving cash flow. An example illustrates the potential savings over 15 years under National’s policy compared to Labour’s. Despite potential negative cash flow in the short term, long-term benefits are anticipated due to a smaller tax bill.
Revisiting Labour’s Policy: Flaws and Repeal
Labour’s policy, aiming to phase out interest deductibility, faced criticism for being retrospective and imposing a high fiscal cost. Inland Revenue expressed concerns about its impact on housing affordability, rent increases, and administrative burdens, ultimately leading to its repeal.
Taxable Profit and Interest Deductibility Simplified
Generally tax is determined on profitability. The higher the profit, the more tax you pay. Profit is based on income, minus your expenses.
Before, the high-level formula to determine taxable profit was Taxable Amount = Rent – Operating Cost – Interest Cost – Chattel Depreciation. Interest Cost was then removed as a deduction, so a comparative table below shows the impact:
Assuming, and illustrative only:
- Rent = $33,800
- Operating Cost = $6,000
- Interest Cost = $20,000
- Chattel Depreciation = $3,000
Before taxable profit was $4,800
When interest cost was removed, the taxable profit was $24,800. You pay more tax on $24,800 than you do on $4,800.
Examples of National’s Impact on Investor’s Tax Bill with Interest Deductibility
Example 1: Julie’s Rental Property
Let’s consider Julie, using our illustrative example above to keep it simple. When interest is deductibile, Julie pays 33% tax on the profit of $4,800, which is $1,584 per annum. Over a 15 year period she has paid $23,760 tax. Now lets compare this tax when there is no interest deductibility.
When there is no interest deductibility, Julie’s taxable profit changes to $24,800 (Rent $33,800 less Operating Cost $6,000, less Chattels Depreciation $3,000) = $24,800. Based on the same tax rate of 33%, Julie will pay $8,184 tax per annum. Over 15 years, this tax paid accumulates to $122,760.
So, $122,760 compared to $23,760 is a staggering $99,000 over 15 years!
Despite potential negative cash flow in the short term, her long-term cash flow would be much better due to a smaller tax bill.
Example 2: New Builds
New Builds enjoy a significant tax advantage under National’s policy, being exempt from higher taxes for at least 20 years. A property qualifies as a New Build if it has a Code Compliance Certificate (CCC) dated on or after March 27, 2020. This includes properties bought off the plans from a developer.
For instance, a New Build with a $1 million mortgage could receive approximately $20,000 in tax benefits per year. This creates a substantial advantage compared to an equivalent existing property, further illustrating the benefits of National’s policy.
Example 3: Social Housing
Investors who rent their properties to entities like Kainga Ora or Registered Community Housing Providers, continue to deduct interest costs under National’s policy. The financial incentive is substantial, with an investor holding a $700,000 mortgage potentially saving up to $14,000 annually.
Social housing is divided into two groups – state housing organized through Kainga Ora and community housing provided by Registered Community Housing Providers. This provides clarity on which properties remain exempt from the new tax rules.
Example 4: Relocatable Homes
Moving or relocating a property, even within a piece of land, allows investors to claim tax advantages. If a property obtains a fresh Code Compliance Certificate (CCC), it is considered a New Build. This rule offers flexibility, as properties moved within a section or even short distances can still qualify as New Builds, provided there is a valid reason for the relocation.
Example 5: Multi-Tenancy Conversions
Converting a single dwelling into two or creating a home and income property makes both new dwellings exempt under National’s policy. This exemption is due to the requirement for a new Code Compliance Certificate when splicing up homes, resetting the 20-year New Build clock. This encourages property owners to explore multi-tenancy conversions for tax benefits.
These examples highlight the diverse ways in which National’s policy impacts different types of properties, providing clarity on exemptions and tax advantages for property investors.
Navigating the New Zealand Interest Deductibility Changes
National’s plan to gradually reinstate interest deductibility brings significant relief to property investors, potentially reducing taxes and improving cash flow. This article emphasizes the importance of understanding the evolving tax landscape until at least 2026. This is because the details of implementation are yet to be formalized by the newly elected government. If an investor, you are are urged to consider Formal Tax Advice from your Accountant. Overall, staying informed and navigating these changes strategically, is crucial for property investors managing their portfolios in the dynamic tax environment of New Zealand
Understanding exemptions, navigating the tax implications based on purchase date, and comparing the impact of different policies will be crucial for you and other investors managing their portfolios, in the changing tax environment in New Zealand.
