Draft legislation, in the form of a Supplementary Order Paper (SOP) to the Taxation (Annual Rates for 2021-22, GST, and Remedial Matters) Bill, has now been released to implement the new tax treatment package for residential property, and is generally scheduled to come into effect on 1 October this year.
A large number of changes are proposed, most of which have been well-signalled, but there is still a lot to unpack.
The SOP will be referred to the Finance and Expenditure Select Committee (FEC), which the Ministerial press statement says is expected to call for public submissions. The FEC’s report back is due 23 March 2022 with the Bill expected to be enacted no later than 31 March 2022.
- The rules will fully deny income tax deductions for interest on borrowing in relation to residential property acquired from 27 March 2021, and will be phased in for residential property acquired before that date, subject to certain exemptions summarised below.
- Interest will remain fully deductible in relation to “new builds”.
- To qualify as a “new build” the property generally has to have received its code compliance certificate (CCC) on or after 27 March 2020. A property that received its CCC up to one year before the rules were announced (on 27 March 2021) can therefore have preferential “new build” status.
- The new build exemption runs for 20 years from the date the CCC is issued and transfers with the property – i.e. successive owners also get the benefit of interest deductions (subject to normal rules governing deductibility).
- Build-to-rent schemes should generally be unaffected during the development phase and for 20 years following completion given the land development business exemption, development land exemption and new build exemption (discussed below).
- Similarly, developers should generally be unaffected given the land development business exemption and development land exemption.
- For companies that are not “close companies”, the limitation rules should not apply if the value of impacted property is below 50% of the value of all company assets.
- Conversions of commercial property into self-contained residences should constitute “new builds”, as well as subdivisions where the housing stock is being increased.
- Interest deductions that have been denied under the rules can be claimed against taxable income on sale of the property (if the sale is subject to tax). For example, if an investor buys a non-new build rental property in 2022 and sells that property in 2026, they will be unable to deduct their interest expense when incurred, but can claim a deduction for the full amount (incurred between 2022 and 2026) against their taxable income under the bright-line test in 2026 when the property is sold. In effect, interest deductions are just deferred rather than denied if a sale is taxable.
Taxation of gains on sale
- A shorter five-year bright-line test (rather than the current 10-year test) will apply for new builds acquired on or after 27 March 2021. The five year test is only available where the property is a new build acquired within 12 months of the CCC being issued. If acquired 12 months after the CCC is issued, the normal 10-year bright-line test would apply.
- Roll-over relief will be available from 1 April 2022 for certain transfers between related parties, including to most family trusts, partnerships, look-through companies, Māori authorities, and as part of a settlement claim under the Treaty of Waitangi. This is in addition to the roll-over relief already available for relationship property settlements and amalgamations, and full relief for transfers on death.
- Roll-over relief will treat the transferee as having acquired the property on the date (and for the cost) that the transferor originally acquired it for both the bright-line test and the phase-out of interest deductibility. There is no roll-over relief for transfers out of a trust (only in), or for transfers between family members (e.g. parents gifting an interest in residential property to children).
Important note: because roll-over relief will only be available for transfers to family trusts from 1 April 2022, transferring an impacted residential property to a family trust right now could have significant adverse tax consequences. We recommend seeking professional tax advice.
Additional design details
Key dates and phase out rules
The general proposal is that from 1 October, interest will not be deductible for residential property acquired on or after 27 March 2021. This rule is subject to various exemptions for new builds, development properties, certain entity types, etc., as discussed below.
For properties acquired before 27 March, the ability to deduct interest is being phased out between 1 October 2021 and 31 March 2025. 75% of the interest expense will be deductible between 1 October 2021 and 31 March 2023; 50% deductible from 1 April 2023 to 31 March 2024; and 25% deductible from 1 April 2024 to 31 March 2025.
For properties acquired before 27 March, the phase-out rules will still apply to loans that are refinanced, but only up to the level of the original loan amount that qualified for the phase-out.
There is some roll-over relief for properties acquired before 27 March but subsequently transferred to associated persons, for example transferred to a family trust. That property will still be treated as having been acquired before 27 March and will be eligible for deductions under the phase-out rules.
Similar relief is available for properties transferred under relationship property settlements and transfers on death (i.e. these do not re-set the effective acquisition date for purposes of phase out eligibility).
New build and property development exemptions
“New builds” of residential properties are exempt, where a new build is generally a residence that receives a Code Compliance Certificate (CCC) on or after 27 March 2020.
It is notable that new builds will remain exempt for 20 years from the date the CCC is issued and the exemption transfers with the property to anyone who owns that property during the 20-year period. Residential properties completed from 27 March 2020 onward, therefore, have special status and will no doubt be preferred by investors relative to housing stock that existed before 27 March 2020.
Conversions of existing dwellings into multiple dwellings and of commercial buildings converted into residential dwellings can also qualify as “new builds”.
Prior to the CCC being issued, the property should also be exempt if the owner holds the land:
- as part of a development, subdivision or land-dealing business or a business of erecting buildings on land (the “land business exemption”), or
- to develop, subdivide or build on in order to create a new build (the “development exemption”) even though the owner is not in the business of developing land.
Interest incurred in relation to remediation work will typically not be deductible unless the work is significant enough for the property to constitute a “new build” once the remediation work is completed.
This does not mean that property developers are automatically fully exempt, although in practice the rules are unlikely to have a material impact given the “land business exemption” and the “development exemption”. The 50% threshold for companies (other than close companies) discussed below also means that many corporate developers may be exempt from the rules.
The rules will not apply to most widely held companies that hold residential property that is incidental to their business, provided less than 50% of the company’s total assets by value are residential properties that would otherwise be subject to these rules.
Widely held companies that exceed the 50% threshold and companies that are “close companies” (five or fewer individuals or trustees own more than 50% of the shares) will need to apply the rules to any affected properties. This may result in a denial of a portion of their interest expense. There is some complexity around how interest expenditure will be traced (or deemed to be traced) to affected properties.
Māori authorities (and companies wholly-owned by Māori authorities or eligible to be Māori authorities) will be treated as widely held and subject to the 50% threshold even if they technically qualify as “close companies”
Community housing providers that are not tax exempt will not be impacted to the extent their interest expenses relate to properties used for emergency, transitional, social and council housing.
Kāinga Ora and its wholly-owned subsidiaries will also be exempt from the rules.
Other properties exempt from rules
In addition to new builds and development properties, certain other residential or quasi-residential types of properties are unaffected. This includes:
- the portion of a main home used to earn income (e.g. if the owner has a flatmate or boarder)
- retirement villages and rest homes
- hotels, motels, hostels, etc.
- houses on farmland
- bed and breakfasts (where the owner lives on the property)
- employee and student accommodation
- property used for emergency, transitional or social housing when leased to the Crown (e.g. Housing and Urban Development or Kāinga Ora) or to a registered community housing provider (CHP)
- land outside of New Zealand, and
- residential land collectively owned by a Māori authority (or an entity eligible to be one) and used to provide housing to a member of the relevant iwi or hapū (papakāinga and kaumātua housing), land transferred as part of a Treaty settlement and certain types of Māori land title.
Bright-line test changes
The SOP also includes the previously announced addition of a separate five-year bright-line test for “new builds”. For the purposes of this rule, a person is only eligible if they acquired the property no later than 12 months after the CCC was issued, and the CCC must have been issued by the time the property is sold.
As a final and welcome change, there is proposed roll-over relief from the bright-line tests (both five-year and 10-year) for transfers of property in certain related party contexts. For example, transfers to most family trusts will no longer trigger the test and re-set the acquisition date.
Similarly, roll-over relief is available for transfers of property to partnerships and look-through companies, for the transfer of land subject to the Te Ture Whenua Māori Act 1993 and for transfers to trusts as part of settling Treaty claims.
As highlighted above, this roll-over relief will only be available for transfers occurring on or after 1 April 2022. This means that there may be a significant disadvantage to transferring impacted property between now and 31 March 2022. For example, it might be disadvantageous to transfer any residential property to a family trust at the moment, unless that property is used exclusively as a main home and that use is not expected to change in the next 10 years.
Please contact our Tax team if you need advice or want help preparing a submission.