Taxes have always been used by governments as a way of encouraging or discouraging behaviour. That is why a packet of cigarettes currently costs around $38 in NZ.
Recent governments have used the tax rules to try unsuccessfully to curb house prices and the popularity of property investment in NZ. Depreciation deductions on buildings were removed from the 2012 tax year, the two-year bright rule applied from 1 October 2015 and increased to five years from 29 March 2018. Ring fencing of residential property losses was introduced from 1 April 2019.
The announcement of the extension of the bright line rule from five to ten years from 27 March 2021 (unless a new build) is therefore unsurprising. It will affect property speculators but should not unduly concern long term property investors buying for yield.
The elephant in the room has always been the exemption of the family home from the bright line rules, so it is pleasing to see that this has been partially plugged if the family home has not been lived in as the main home for the duration of ownership.
However, the non-deductibility of interest for residential property investors changes one of the fundamental concepts of tax law in NZ – that interest incurred in earning assessable income is deductible against that income. That will upset a lot of people and could potentially cost Labour the next election.
For positively geared property the non-deductibility of interest means investors will be paying more tax, possibly at 39% from 1 April 2021 for those investors earning more than $180,000 personally.
The impact of non-deductibility of interest will be felt more keenly when interest rates inevitably rise from their current historic lows.
The non-deductibility of interest will be phased in and will not take effect for existing loans until 1 October 2021. Interest deductions will not be completely phased out until 1 April 2025 which gives investors time to do their numbers and make informed investment decisions. It also gives property investors who own other business interests an opportunity to restructure more tax effectively.
A National government could also be re-elected in several years and decide to reverse the rule change. Investors should therefore not make hasty decisions they may later regret.
Although the rule changes will inevitably impact the popularity of residential property investment, it remains a great asset class for hands on building of retirement income and capital… residential property is generally inflation proof, provides regular rental income, is relatively low risk, and banks happily lend against bricks and mortar.
As Warren Buffet says:
“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes”.
Sounds about right to me.