New Zealand government announces drastic reform of residential property tax

At the end of March 2021, the New Zealand government announced a housing package containing significant tax reforms aimed at increasing the supply of housing and removing incentives to curb so-called “rampant speculation”.

The housing package contains two main fiscal policy measures:

• A recently enacted extension of the residential light line test (which considers the proceeds from the sale of a residential property (other than a person’s primary residence) during a specified period to be taxable) from 5 to 10 year ; and
• A proposal to remove interest deductions for residential real estate investors.

No more deductions for interest expenses

The proposal to remove interest deductions for residential real estate investors is by far the more controversial of the two measures.

Currently, a taxpayer can deduct the cost of interest expenses incurred in the production of income, for example rental income.

The government proposes to ban interest deductions from October 1, 2021 for all residential property acquired on or after March 27, 2021. It will also ban interest deductions for money borrowed after March 27, 2021 for maintain or improve the property, even if the property was acquired before March 27 2021.

For existing real estate investors with outstanding loans (i.e. for property purchased and money borrowed before March 27, 2021), interest deductions will be phased out by 25% each year during the four coming years. As of April 1, 2025, none of the interest charges will be deductible.

The government has suggested that real estate developers, who would have to pay taxes on gains from the sale of their properties, can continue to deduct interest expenses.

This measure is likely to have a considerable impact on the after-tax profit on rental income of residential property investors. It will not otherwise change the way the property is taxed (or not) when it is sold.

Significantly, the Treasury advised the government against following up on this proposal at this stage, due to “time constraints and lack of analysis”. However, the government has announced that it will consult on the details of this proposal before introducing a bill ahead of the planned implementation date of October 1, 2021.

Double light line period

The second key measure of the government program is the extension of the residential light line test from five to 10 years. This measure entered into force on March 27, 2021.

The clear line test now requires that income tax be paid at a taxpayer’s marginal tax rate on gains realized on the sale of a residential property within 10 years of its acquisition, subject to several exceptions. Among other exceptions, the light line test does not apply if the residential property is the taxpayer’s “primary residence” or if it was acquired by inheritance.

The new 10-year period applies to all residential property acquired on or after March 27, 2021. If sold within 10 years of acquisition (provided no exclusions apply), the taxpayer will draw taxable income from the proceeds of the sale.

The government has also adopted measures to limit the way in which the exclusion of “principal residence” can be invoked by taxpayers. Previously, the exclusion applied if the property was used as a principal residence “for the most part” of the peak period. The exclusion as amended now takes into account a period during which the criterion of the main domicile is not satisfied and, if this period exceeds one year, the reference period is effectively extended.

In line with its goal of increasing the supply of housing, the government has also proposed to grant preferential treatment to “new constructions”, which will only be subject to a period of five years. However, it has not yet determined how “new construction” will be defined, and such an exemption will be presented to Parliament after further consultation.

Fred ward

Partner, Russell McVeagh

Isabelle collins

Legal Assistant, Russell McVeagh

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