New Zealand: Government announces drastic residential property tax reform

In late March 2021 the New Zealand government announced a housing package containing significant tax reforms aiming to increase housing supply and remove incentives to curb so-called ‘rampant speculation’.  

The housing package contains two principal tax policy measures: 

• A recently enacted extension to the residential bright-line test (which deems the proceeds of selling residential property (other than a person's main home) within a specified period to be taxable) from 5 to 10 years; and
• A proposal to remove interest deductions for residential property investors.  

No more deductions for interest expenditure

By far the more controversial of the two measures is the proposal to remove interest deductions for residential property investors.

Currently a taxpayer can deduct the cost of interest expenditure incurred in the course of deriving income, for example, rental income.  

The government proposes to disallow interest deductions from October 1 2021 for all residential property acquired on or after March 27 2021. It will also disallow interest deductions for money borrowed after March 27 2021 to maintain or improve property, even if the property was acquired before March 27 2021.

For existing property investors with outstanding loans (i.e. for property bought and money borrowed before March 27 2021), interest deductions will be phased out by 25% each year for the next four years. From April 1 2025, none of the interest expense will be deductible.

The government has suggested that property developers, who would be expected to pay tax on the gains from the sale of their properties, will be able to continue to deduct interest expenditure.  

This measure is likely to impact considerably on the after-tax profit on rental income derived by residential property investors. It will not otherwise change the way that property is taxed (or not) when it is sold.

Significantly, the Treasury advised the government against proceeding with this proposal at this stage, due to “time constraints and lack of analysis”.  However, the government has announced it will consult on the detail of this proposal before introducing legislation in advance of the expected October 1 2021 implementation date.

Bright-line period doubled

The second key measure of the government's package is the extension of the residential bright-line test from five to 10 years. This measure came into force on March 27 2021.  

The bright-line test now requires income tax to be paid at a taxpayer's marginal tax rate on gains made from the sale of residential property within 10 years of its acquisition, subject to several exceptions. Among other exceptions, the bright-line test does not apply if the residential property is the taxpayer's ‘main home’ or if it was acquired by inheritance.

The new 10-year period applies to all residential property acquired on or after March 27 2021. If sold within 10 years of acquisition (provided no exclusion applies), the taxpayer will derive assessable income on the proceeds of sale.

The government also enacted measures designed to limit the way the ‘main home’ exclusion can be relied on by taxpayers. Previously, the exclusion applied if the property was used as a main home ‘for most of’ the bright-line period. The exclusion as amended now takes into account a period in which the main home criterion is not satisfied and, if that period exceeds a year, the bright-line period is effectively extended.  

Consistent with its aim to increase housing supply, the government has also proposed to provide preferential treatment to ‘new builds’, which will only be subject to a five-year bright-line period. However, it has not yet determined how a ‘new build’ will be defined, and such an exemption will be introduced to Parliament after further consultation. 

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