A few months ago, the NZ government announced they would be removing interest deductibility from rental income on residential properties here in NZ. This is part of the greater move to bring house prices in NZ under control. This move has caused quite a stir in the property owning community – but we’re not here to talk about the wisdom of that rule.
Nope, we’re here to talk about how it’s going to work, from a tax point of view.
How does interest expense work now?
Currently, we can deduct 100% of all interest expenses relating to mortgages taken out on residential investment properties. Yay!
This means that if you paid $30,000 worth of mortgage interest a year, you can use that to offset your rental income of $40,000 a year. This means that you only pay tax on the remaining $10,000.
You don’t need to be a comic-drawing accountant to know that paying tax on $10,000 is waaaaay less than paying tax on $40,000.
What will happen to interest deductibility?
Interest deductibility is going to be phased out.
In short, we cannot claim interest expenses to offset our taxable rental income.
To put it more bluntly, instead of using $30,000 worth of mortgage interest to offset our $40,000 a year income, we now are just paying tax on that $40,000.
Ouch.
But I won’t question the wisdom of the rule. I am a prospective first home buyer so theoretically I will benefit from it (maybe?), but at the same time I have clients who are landlords that will be affected by this.
When will we stop claiming interest expenses?
The journey to zero interest deductibility will be a long one as the government plans to phase it out in stages. The most important dates to remember right now is:
27 March 2021
And
1 October 2021
Properties purchased using loans made after 27 March 2021 will not be able to claim ANY interest expense deductions starting from 1 October 2021. Full Stop.
This also applies to loans made after 27 March 2021 used to improve properties bought before 27 March 2021.
This means that if you bought property on 1 April 2021, you can still claim interest expenses on it until 1 October 2021, after which you can’t claim anymore.
Properties purchased before 27 March 2021 will still be able to claim interest expenses, however the amount of interest claimable will decrease according to the following table:
As you can see, this amount decreases starting from 1 October 2021 and goes down every subsequent financial year. Interest deductibility will be completely wiped from 1 April 2025 onwards.
What else do I need to know?
Not much else really – it’s pretty straightforward. There is some trickiness if you made an offer on a property before 27 March 2021, but acquired the property after 27 March 2021. According to IRD, the property is still treated as being acquired before 27 March 2021.
It is also important to note that any NEW borrowings after 27 March 2021 (even on a property acquired before 27 March 2021) will not be able to have it’s interest deducted. So this is worth remembering before taking out any home improvement loans on your residential investment property.
This ruling DOES NOT affect interest deductibility for other businesses though. So if you run a coffee cart and want to take out a business loan, you still can claim interest expenses on that business.
If you have taken out a loan for a commercial property, you can still claim interest expenses on that property. This is the distinction between commercial and residential property.
Interestingly enough, interest for loans taken on new builds can be deductible though. Although expect there to be some confusion over how that will work while the Government tries to refine this new tax ruling.
That’s about it really. For more information, check out the IRD factsheet on the matter.
In the meantime
Stay positive!