(interest deductibility – 3 minute read)
Hi Accounting fans!
Here’s a NZ tax update for you. Last year the IRD announced that they were looking at proposals to remove interest expense deductibility on rental properties.
Here’s how it works:
Interest deductibility removal
Here are the key points of the interest deductibility phase out/removal rules:
- Properties bought before 27 March 2021 will have interest deductibility slowly phased out
- Properties bought after 27 March 2021 will not be eligible for interest deductibility
HOWEVER
New build properties are exempt from this ruling. Meaning that you can claim interest expense on new builds. Don’t know what defines a ‘new build’? Money Empire has a definition for it here. Also, you can check with your developer if the property you are buying is a ‘new build’.
Interest deductibility only relates to rental income. Meaning that you can’t deduct interest expense from rental income to bring down your taxable income. You can still claim a portion of your own home’s mortgage interest as part of home office expenses, if you are self employed/a business owner.
Naturally this means that landlords will now be paying higher taxes since they can’t claim the biggest expense on their rental properties. With interest rates currently on the rise, rental property owners will really feel the pinch!
Working out interest deductibility
For those who own rental properties bought before 27 March 2021, interest deductibility will be phased out starting from 1 October 2021 according to this table:
Narayan owns a rental property that he purchased in April 2019. In the financial year ending 31 March 2022 (the one we’re in at the time of publication), he incurred interest expense of $13,000.
For this tax year, since is it transitory, he can claim 100% of the interest expense from the months 1 April to 30 Sep 2021. He worked out interest on those months to be $6,800. This amount is fully claimable
The remainder of $6,200 interest is for the months 1 Oct to 31 March 2022. Of this amount, he can only claim 75%. Therefore he can claim only $4,650 ($6,200 X 75%).
In total, for the year 2023, Narayan can only claim $11,450 ($6,800 + $4650) as interest expense for the year ending 31 March 2022. He cannot claim the full $13,000 (like in previous years).
What happens with interest in the coming years?
From 1 April 2022 onwards, interest deductibility % will reduce by 25% each financial year until it is 0% from 1 April 2025 onwards.
Using Narayan as an example, he can only claim 75% of interest in the financial year ending 31 March 2023. 50% in the financial year ending 31 March 2024, 25% of interest in the financial year ending 31 March 2025. Starting 1 April 2025 he can no longer claim interest for tax deductions.
This has the effect of reducing the tax attractiveness of owning residential rental properties. Will this slow down the growth of the property market? Only time will tell. I’m not here to debate the merits of the ruling. I’m here to educate you on how to correctly calculate interest rate deductibility for your rental property.
I hope that this article has been helpful in preparing your upcoming rental income tax return!
Stay positive!
Sam