The Government’s release of draft legislation this week was disappointing on a number of fronts.
First, what was expected to be complex legislation has been successfully made nearly indecipherable. Second, it is of course disappointing that they are pressing ahead with the rules being effective from 1 October despite only this draft version being available to taxpayers at this time. Third, there is no detailed commentary to accompany the draft.
In working through this, it is important to bear in mind that this draft legislation is yet to go through the select committee process, so there is a chance of details changing between now and when it finally becomes law.
Bits that were as we expected
- A five-year bright-line period has been brought in for new builds.
- New builds have been defined as property purchased within 12 months of their code compliance certificate (CCC) being issued, with that CCC being issued on or after 27 March 2020. (Note this is not a typo – the date for the issue of CCC is on or after 27 March 2020, being one year before the 10-year bright-line period applies.)
The interest deductibility rules kick in from 1 October 2021 as expected, and there are exemptions for:
- Renting out part of the main home.
- Business premises – this excludes a business that involves the provision of accommodation, unless it is a hotel, motel, inn, hospital etc. Boarding houses are notably not included in this list of business premises, which suggests an intention for them to be caught by the new rules. I suspect there will be more to come on this.
- Property bought as part of the business of dealing in or developing land or erecting buildings.
- New builds – more information on this below.
The government has followed through on extending the “rollover relief” rules. Rollover relief means you can transfer property within your structure without triggering adverse tax consequences (like resetting the bright-line period for 10 years). Under this draft legislation, rollover relief will apply to the transfer of residential land or a property that is subject to the interest deduction limitations by an individual(s) to a trust, provided that the individual(s) transferring the property are beneficiaries of the trust and the principal settlors; and every beneficiary of the trust is associated to that individual(s).
It appears this will apply to transfers on or after 1 April 2022. This is excellent news and will open up scope for transferring property into trust ownership.
There is also rollover relief when transferring residential land or property subject to the interest deduction limitations to an LTC where the shareholding in the LTC mirrors the ownership of the land pre-transfer. I see this as being of less significance, as there is typically unlikely to be much advantage gained by transferring a property held personally into an LTC where you own the shares personally.
It is also confirmed that the existing rollover relief that applies to transfer of assets under a relationship property agreement also applies for the purposes of the interest deduction limitation rules.
Main home exemption
The main home exemption has now undergone a further change for bright-line purposes. This exemption currently applies as long as most (i.e. more than 50%) of the property in question is used as a home. This has meant that if you rented out 50% or more of a property, so that you cannot say it was mostly used as your home, then you got no relief under the main home exemption. In other words, you would have had to pay tax on the full gain if the property was sold within 10 years of acquisition.
A new proportionate approach is now able to be applied where less than 50% of the property is used as the main home. By way of simple example, if you applied 25% of a property acquired on or after 27 March 2021 to your own private residential use, and then you sell it within the bright-line period, 25% of the gain realised on sale will be exempt.
New build exemption
The new build exemption for the interest deduction limitation rules applies for a fixed 20-year period. This means that if you have a property that qualifies as a new build, then interest can be claimed for a period of 20 years from the issue of CCC by all owners during that period who rent it out residentially.
As noted above, a new build is a property where CCC has been issued on or after 27 March 2020. This opens up scope for interest incurred on properties bought prior to the announcement in March 2021 continuing to be deductible under the new build exemption – subject to the 20-year time period.
Interest can be offset upon sale
Denied interest deductions can be offset against taxable gains realised on sale of the property if that sale is taxable either due to the application of the bright-line rule or other provisions (for example the tainting provisions). While this is what we perhaps should have expected, as it is only fair for the interest costs incurred by an investor to be allowed as a deduction if taxable income arises on sale, this was not guaranteed so it comes as a pleasing inclusion.
Social housing exemption
Also exempt from the interest deduction limitations are properties that are applied towards provision of social housing. This means if you rent your property to Kainga Ora or a registered community housing provider, who in turn uses the property to provide social housing or temporary accommodation for people in need, then you can continue to claim interest deductions. This exemption is better than the new build exemption because there is no time limit attached. You get ongoing interest deductibility for as long as the property is applied towards this purpose.