Interest deductibility changes – the devil in the detail
Tax & Accounting14/06/2021 11:36:00 PM

Interest deductibility changes – the devil in the detail

In March this year, the Government made the shock announcement that deductions for interest expenses on residential rental properties will be curtailed from 1 October 2021. On Thursday 10 June, more detail on the proposal was revealed with the release of a discussion document. 

To re-cap on the core announcements already made:

  • For residential investment property acquired before 27 March 2021, interest deductions on loans will be gradually phased out between 1 October 2021 and 31 March 2025. 
  • For residential investment property acquired after 27 March 2021, interest deductions will immediately cease to be deductible from 1 October 2021.
 Date interest incurred Percent of interest you can claim
 1 April 2020 to 31 March 2021
  • 100%

 1 April 2021 to 31 March 2022 (transitional year)

  • 1 April 2021 to 30 September 2021 – 100%
  • 1 October 2021 to 31 March 2022 – 75%
 1 April 2022 to 31 March 2023
  • 75%
 1 April 2023 to 31 March 2024
  • 50%
 1 April 2024 to 31 March 2025
  • 25%
 From 1 April 2025 onwards 0%
  • 0%

The discussion document expands significantly on this framework.

The proposals contain some important exceptions to the prohibition on interest deductions, including:

  • new builds (and these will be subject to a 5-year bright-line test rather than a 10-year bright-line test)
  • property that qualifies as a development (which is sometimes a pre-cursor to a “new build”)
  • houses on farmland
  • short-stay accommodation where the owner lives on the property (eg Airbnbs)
  • a portion of the main home if it is used to earn  income from flatmates or boarders
  • employee accommodation. 
  • student accommodation, retirement villages and care facilitates (eg hospitals/hospices/ rest-homes)
  • commercial accommodation such as hotels, motels, camping grounds and boarding houses. 

The Government is seeking feedback on mixed commercial/residential properties (eg a shop with a flat above it) and some short-stay accommodation/serviced apartments. 

Some taxpayers will be exempt from the prohibition on interest deductions:

  • any company (aside from a close company) with assets of residential property if that comprises 50% or less of the total assets owned
  • Kāinga Ora (the Crown agency that provides rental housing).

Close companies (ie, companies that have five or fewer natural person shareholders) will be subject to the prohibition on interest deductions.

Exemption for new builds

The carve out for new builds is clearly a key one. “New build” will be a defined term and will have 3 categories: simple new builds, complex new builds and commercial-residential conversions. 

Central to the definition of new build is the concept that the residential housing supply has increased.  A self-contained dwelling (with its own kitchen and bathroom) must be added to residential land and the dwelling must have received a code compliance certificate (“CCC”). 

Under the proposal, a new build includes: 

  • adding a dwelling to bare land
  • replacing an existing dwelling with one or more dwelling(s)
  • adding one or more self-contained dwellingto land that already has an existing dwelling
  • attaching a dwelling to an existing dwelling
  • splitting an existing dwelling into multiple dwellings 
  • conversion of commercial dwellings into self-contained dwellings (eg converting an office block into apartments)

A renovation of an existing dwelling that does not result in an additional dwelling on the land would not be eligible as a new build. 

The general rule is that only new builds with a CCC issued on or after 27 March 2021 are eligible for the new build exemption. In such cases, the exemption applies to the “early owner”. The early owner is a defined term that includes the builder, a purchaser off the plans and a purchaser who acquires the property within 12 months after the CCC is issued. 

The Government is consulting on whether the new build exemption should also extend to subsequent purchasers

Existing apportionment rules will apply to where a new build and an existing dwelling are on the same title.

Can interest be deducted when the residential property is sold?

The discussion document says that “design details have not been decided” at this stage, leaving the door open for the possibility of an interest deduction being allowed on sale. The paper lists 4 options for this:

  • deductions denied at all stages
  • deductions allowed, but deferred to time of sale
  • deductions allowed at time of sale to the extent they do not create a loss
  • deductions allowed at time of sale, but interest that exceeds the gain on disposal is ring-fenced.

Feedback invited

The Government is seeking submissions on all aspects of the proposals.   The closing date for submissions is 12 July 2021.