2021 BRIGHT LINE CHANGES AND INTEREST CLAIMABLE
The bright-line test (shown in the chart below) has been increased from five years to ten years for investors who do not use the property as their main home.
This is not a blanket rule for all property investors - there are exclusions. While the ten year rule is already effective, changes to mortgage interest claiming will be phased in over four years.
The bright-line test means that if you sell a residential property within a set period after acquiring it you will be required to pay income tax on any profit made through the property increasing in value.
The 10-year bright-line test will apply to eligible houses bought on or after March 27 2021. Previously the bright line test was five years which still applies to properties bought prior to March 22, 2021.
The family home and inherited property continue to be exempt from the bright-line test.
For a quick reference to whether you will be affected by the changes, see the IRD flow chart below.
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CHANGES TO CLAIMING INTEREST ON RENTAL PROPERTY
In addition, property investors will no longer be able to offset their mortgage interest expenses against their rental income when calculating their tax.
The full effect of these changes will not come into play until 2025 to give investors time to adjust.
Interest on loans for properties acquired before March 27 2021 can still be claimed as an expense. However, the amount someone can claim will be reduced over the next four income years until it is completely phased out by April 1, 2025.
The incremental reduction in interest deductibility to 2025 is as follows:
- April 1 2020-March 31 2021 100% Claim
- April 1 2021-September 30 2021 100% Claim
- October 1 2021-March 31 2022 75% Claim
- April 1 2022-March 31 2023 75% Claim
- April 1 2023–March 31 2024 50% Claim
- April 1 2024–March 31 2025 25% Claim
- From April 1 2025 onwards 0% Claim
BRIGHT LINE TEST FOR NEW BUILDS
The bright line test on new builds will remain at five years.
Legislation to define 'new builds' and exclude them from the proposed 10-year test is intended to be introduced into Parliament after consultation.
CHANGE OF USE RULE FOR RESIDENTIAL HOMES
The Government is also making the rules fairer around the change of use of a main home with respect to the operation of the bright-line test.
Any home that has been the owner's main home for the entire time they owned it will continue to be exempt from any bright-line test.
For residential properties acquired on or after March 27 2021, including new builds, the Government intends to introduce a 'change-of-use' rule.
This will affect the way tax is calculated if the property was not used as the owner's main home for more than 12 months at a time within the applicable bright-line period.
If a property switches to or from being the owner's main home and the period when it is not their main home is 12 months or less, they do not need to count that as a change-of-use.
For example, if an owner takes a few months to move into a property, or owns it for a few months after moving out, this does not trigger the bright-line test.
The owner of a property subject to the change-of-use rule will be required to pay income tax on a proportion of the profit made through the property increasing in value, calculated as follows:
• subtract the purchase price from the sale price
• subtract the cost of capital improvements the owner has made
• subtract the costs to buy and sell the property, and
• multiply the result by the proportion of time the property was not being used as the owner's main home.
If a residential property was acquired on or after March 29, 2018 and before March 27 2021, the existing home exclusion rules will continue to apply.
HOUSE SALE PROFITS WILL AFFECT WFF AND MORE
Any profit from a gain in property value that is considered taxable income (including under any of the bright-line tests) will also affect any other obligations or entitlements you have based on taxable income, such as student loan repayments, child support payments and Working for Families.
BRIGHT LINE TEST ON SHORT-STAY ACCOMMODATION
The legislation has also amended the “business premises exclusion” in the definition of “residential land” to ensure that residential property used to provide short-stay accommodation is subject to the bright-line test where the accommodation is provided in a dwelling that is not the owner’s main home.
OTHER LAND SALE RULES STILL APPLY
There are other rules in the Income Tax Act 2007 that can tax gains on the sale of land (including residential land).
For example, there are tax rules that apply to speculators, land developers and dealers. Those rules will continue to apply, regardless of when the property was purchased. The bright-line tests potentially apply only if none of the other land sale rules apply.
Regardless of the bright-line tests, anytime you purchase property with the intention of selling it you must pay tax on the profit unless an exemption applies.
Planning to sell your investment property? Talk to us first. We can help you maximise your sale price.
Article updated June 17, 2021 | Trish Willis
Disclaimer: the content of this article is general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.