Historically, just about anyone could get wealthy from residential property investment so long as they followed basic property investment rules:
- Able to service the debt, and
- Hold for the long term, and
- Start as early as possible.
Even before the recent property tax changes property flicks left a lot of money on the table. Holding costs, buying and selling costs, income tax, and potentially GST as well, erode the realised gains. The opportunity cost of time spent executing the deals is also significant.
But, if you bought and held property for the long term then capital gains accumulated (and were tax free), allowing you to leverage the increased equity to buy further property.
However, the residential property investment landscape has now changed.
Firstly, Tax Free Short Term Capital Gains were Shot Down
The Brightline rule taxing short term capital gains on residential rental property were introduced by National – initially for property sold within 2 years of purchase. Labour increased the Bright Line period to 5 years, and since March 2021 it is 10 years.
Read more about the Bright Line changes here.
This change doesn’t impact if your residential property investment strategy is to hold for the long term. But the Brightline tax rules do catch people whose situation changes or who decide to sell for some reason – tax law can be a blunt instrument.
Secondly, Negative Gearing was Shot Down
Negative gearing (a flash way of saying your property was making a loss) was often seen as smart, especially for high income earning individuals. It (almost) made sense if you were in the top tax bracket as property losses reduced your taxable income, while capital gains were tax free.
But then “loss ring fencing” tax rules were introduced. Now a loss on residential property must be carried forward and can only be offset against future residential property income.
Thirdly, Interest Deductibility was Shot Down
For strategic long term investors tax free capital gains and negative gearing were simply “nice to haves”. However, interest paid on money borrowed for business or investment purposes has historically always been tax deductible. That basic tax “right” was changed in March 2021 for residential property investors. Read more about the Interest Deductibility rule changes here.
The tax change was introduced to discourage investment in existing residential property and to encourage “new builds” which are exempt from the interest deductibility clamp down, potentially for up to 20 years.
Is Residential Property Investment now a Dead Duck?
In a single word “NO!”. But you do need to be even smarter and more strategic than previously.
You must understand the current tax rules and plan for the long term. Even more importantly, be clear on your investment objectives and take professional advice – it is complex and getting it wrong will be costly.
Always hope for the best,
But prepare for the worst!