Residential land – where are we now?
Tax Alert - April 2022
By Robyn Walker
The taxation bill containing changes to the taxation of residential property has now been enacted and all that is left to do is for taxpayers to understand and implement the rules. While opposition parties have stated that these rules will be repealed if there is a change of Government at the 2023 election, at a minimum these rules will have effect for at least 2 tax years and they can’t be ignored.
There are two main sets of rules that taxpayers need to be aware of:
- Interest deductibility for residential rental properties
- The bright-line test
Before explaining the rules, it’s worth noting that Inland Revenue collects extensive amounts of information about residential property (including details of rental property expenditure and property sale information), so property owners should take compliance with these rules seriously. It is not a question of if, but when, Inland Revenue will be coming knocking to check on compliance with these rules.
The following is a high-level summary of the rules; however readers should note there are some detailed in’s and out’s for certain circumstances which are not covered in this article. Given the quantum of tax that can be at stake when dealing with residential property and the complexity which now exists in these rules, it is worth seeking professional advice to confirm how any tax rules applies.
The interest deductibility rules have a number of layers to understand, which we can break down into some key questions:
- What property do the rules apply to?
- Who do the rules apply to?
- What interest do the rules apply to?
- When do the rules apply?
What property do the rules apply to?
The interest deductibility rules apply to residential property which satisfies the definition of ‘disallowed residential property’ (DRP). The following lists help to explain what is DRP.
What is DRP
What is not DRP
Overlaying the definition of DRP are some further exemptions:
- ‘New build’ properties are exempt from these years for 20 years after a property has received its Code Compliance Certificate (CCC). A new build is a property that has received a CCC on or after 27 March 2020, however, there are some other property types that can also satisfy this definition.
- Land which is acquired for a business relating to land (under section CB 7 of the Income Tax Act 2007) is exempt from the rules. That is, land developers will always continue to be able to claim interest deductions.
- Land which is being used as part of an undertaking or scheme to develop residential land is excluded from the rules while land development is being undertaken. Once the building is completed the new build exemption applies.
- Residential properties which are used for social housing by registered community housing providers or council-controlled organisations. This exclusion also applies to landlords who rent their properties to these organisations.
Who do the rules apply to?
These rules apply to anyone owning residential property; however, a company will only be subject to the rules if:
- It is a close company (generally a company with five or fewer natural persons or trustees who have more than 50% of the voting interests);
- It is not a close company but 50% or more of the total assets are DRP (this is measured on a group basis);
- It is not an exempt Maori company.
As borrowing money to acquire shares is tax deductible, to prevent the obvious work-around of someone borrowing money and investing this into a company that then buys residential property without any debt, the rules will also apply to:
- Someone who has borrowed money to acquire shares in a close company that has more than 10% of its total assets as DRP (this threshold is measured quarterly);
- Someone who has borrowed money to acquire shares in a company that is not a close company, and the company has more than 50% of its assets as DRP (this applies when the threshold is exceeded at any point during the income year).
These are known as ‘interposed residential property holders’. These taxpayers will need to perform quarterly calculations.
When do the rules apply?
Factoring in the exemptions above, for DRP which was acquired on or after 27 March 2021, interest stopped being tax deductible in full on 1 October 2021.
For most DRPs acquired prior to 27 March 2021, interest deductions became partially non-deductible from 1 October 2021, and interest deductions will be phased out in totality by 1 April 2025.
Percentage of interest denied
1 October 2021 – 31 March 2022
1 April 2022 – 31 March 2023
1 April 2023 – 31 March 2024
1 April 2024 – 31 March 2025
On or after 1 April 2025
Landlords who are subject to these rules will need to determine what borrowing they held in relation to DRP as at 26 March 2021. Any ‘new borrowing’ after that date is also fully non-deductible from 1 October 2021.
What interest do the rules apply to?
It will be necessary for landlords to determine what borrowings relate to DRP. This will be straightforward for many landlords who may have a special purpose loan related to a rental property. However, to the extent there is borrowing which is for mixed purposes, or which is ‘revolving credit’ this will be less straightforward.
For a mixed purpose loan, reasonable attempts must be made to allocate portions of the loan to DRP and other property. If this is not possible, the approach is to subtract the value of other property (as at 26 March 2021) off the loan balance, with the residual balance being attributed to DRP.
For revolving credit loans, the loan balance as at 26 March 2021 represents the upper limit of deductible interest. To the extent the loan increases above that balance, any interest on that component is non-deductible from 1 October 2021. Any fluctuations up and down below the upper limit are not treated as ‘new borrowings’ and continue to be subject to the phase-out rule.
Whilst new borrowing is fully non-deductible, refinancing an existing loan (including changing banks) or transferring borrowing to another person where rollover relief is available will not constitute new borrowing. Foreign currency loans are also fully non-deductible from 1 October 2021, however, these can be refinanced into a New Zealand dollar-denominated loan.
If a property is sold and ends up being subject to tax (for example it is sold within the bright-line period), previously denied interest deductions may become deductible when determining the taxable profit on the property.
The residential ring-fencing rules continue to apply. These rules defer tax deductions if residential property expenses exceed residential property income.
The bright-line test was amended in 2021 to change the bright-line period to 10-years for any property acquired on or after 27 March 2021. The changes in 2021 also included a modification to the main home exemption. The main home exemption no longer applies on an all or nothing basis; instead, the main home will be subject to tax if sold within the bright-line period to the extent that the owner has been out of the property for a continuous period of 365 days or longer. It’s important to note this change to the main home exemption also only applies to property acquired on or after 27 March 2021.
The most recent changes have made some positive modifications to the bright-line test to take some of the harsh edges off the rules:
- The bright-line test will only be 5-years for ‘new build’ property. The definition of a new build is consistent with the interest deductibility rule, however, only those taxpayers who have acquired a new build within 12-months of the property receiving a CCC are eligible for this concession, it does not pass on to subsequent owners.
- The 365-day rule for the main home exemption provides a concession for taxpayers who purchase bare land and need to construct a dwelling. It has been acknowledged that it can take well in excess of 12-months for a property to be designed, consented and built, and therefore any reasonable period will count toward the main home exemption.
- The rules recognise that transactions that change the ‘legal owner’ of a property without changing the ‘economic owner’ should not trigger a sale under the bright-line test. Anyone wanting to rely on one of the following exemptions should ensure that they will comply with the black letter of the law before entering a transaction, as the exemptions are fact-specific and some only apply to transactions occurring on or after 1 April 2022:
- The trustees of a trust have changed;
- The land has been subdivided, with the original owner now holding more property titles for the same area of land; or conversely an amalgamation of separate titles into a merged title;
- A change from joint tenancy to tenancy in common, or vice versa;
- Land transfers for certain family trusts – including in and out from trustees and original settlors;
- Land transfers to Māori authorities and associates or transfers associated with a settlement of a claim under the Treaty of Waitangi;
- Transfers to themselves in a different capacity, for example between a look through company and its owner or a partnership and a partner;
- Transfers between members of a tax consolidated group.
Unfortunately there have been no substantial changes to assist parents who help their children purchase property, as discussed in our previous article.
For more advice on these rules please contact your usual Deloitte advisor.
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