Today the Government renewed its war on residential landlords and announced some major changes in the property sector. Obviously, the house price increases we have seen in the past couple of years are unsustainable and are having significant social impacts. Therefore, there is no doubt that action was needed. However, we think that the Government has once again overstepped the mark in its ideologically driven attack on the residential investment sector and has taken the opportunity to sneak in some tax increases.
The good
We will start with the good aspect of today’s announcement. The Government is setting up a $3.8b fund to assist in the creation of infrastructure to free up the supply of land to build houses on. The lack of new housing in the past 20 plus years is the root cause of the current housing crisis, and the fact that councils cannot afford infrastructure is acting as a barrier to subdivisions being approved. Even where councils are approving subdivisions, they are seeking very high developer contributions to fund infrastructure and this is adding a significant cost to land.
It seems this fund will take some time to be operational as officials are to report back to Cabinet in June. Hopefully, Labour implement this policy better than they implemented KiwiBuild!
Also, the income caps and regional caps for first home buyers for existing Government assistance packages are being increased to reflect current values. These changes will be much welcomed for those trying to buy their first home as the old values were too low to buy a property in most areas.
The bad
As was widely expected, the Government has broken its no new taxes or tax increases election promises and has doubled the “bright line” period from 5 to 10 years. This means that any gain made on the sale of any residential land (that is not the owner’s main home) acquired on or after 27 March 2021 will be taxable on sale.
New builds will be excluded from the extension of bright lines. In other words, any new builds acquired from the 27th of March will be subject to the existing 5-year test. In the context of what the Government wants to achieve, it would make more sense to exempt new builds from bright-line altogether.
The bright-line rules increase house prices as they act as a barrier to sale. Since bright-line was extended to 5 years we have frequently had conversations with clients about selling properties where the outcome of the discussion is that they will choose to hold onto the property for another couple of years so the sale is not taxable. This adds to the already chronic shortage of properties and increases upward pressure on prices.
Interestingly, an item currently sitting on the Inland Revenue’s work programme is to investigate the removal of various 10-year rules in the land tax provisions as these rules create “lock-in”. That is by forcing land to be held for 10 years before sale or subdivision, properties are held for longer than they might otherwise be. Obviously, this is a constraint on supply and causes upward pressure on prices. Further, in submissions to the 2017 Tax Working Group, Government Officials submitted that a capital gains tax would increase house and rent prices for the same and other reasons. With that in mind, it is beyond belief that the Government actually expects that increasing bright-line to 10 years will in any way ease pricing pressure. Therefore, this is nothing but a tax grab.
Since bright-line was increased from 2 to 5 years, we frequently see that the bright-line rules overreach and capture transactions that should have never been taxable. This overreach is going to become far worse under a 10-year rule if there are not tweaks to the bright-line rules.
The ugly
Under the guise of fixing a significant tax “loophole”, the Government is ending interest deductions for residential landlords. Of course, any talk of a loophole is an outright lie – this is a myth that the left continually sells to the financially illiterate. The Income Tax Act 2007 allows a deduction for interest paid on money borrowed for the use in a business or for the purposes of deriving income. There has never been a loophole.
These rules will apply from 1 October 2021. For properties acquired on or after 27 March 2021, there will be no interest deductions after 1 October 2021. For properties acquired before 27 March 2021, interest deductions will be phased out over the next 5 years. Dropping to 75% from 1 October 2021 and then reducing in 25% increments until there are no further interest deductions from 1 April 2025.
The especially troublesome aspect of this is that the removal of interest is going to apply to existing landlords as well as those who buy now. For existing landlords, interest deductions will be phased out over 4 years. Back-dating of laws or “retrospective legislation” is frowned upon in New Zealand and other democracies. New Zealand typically does not backdate laws except to plug major holes that are being exploited. Landlords made decisions to buy properties based on the expected cash-flows so by back-dating the change, the goalposts are being shifted on them.
This change is significant and there is no doubt it will lead to rent increases as landlords will look to recover this cost from tenants.
This rule only applies to residential rental landlords. Developers will still be able to claim a deduction for interest and new builds will be exempt.