Interest limitation on residential investment property

The Government has released draft legislative proposals to limit interest deductibility for residential property investments. Previously, interest payments could be claimed as a business expense, giving property investment a tax advantage.  From 1 October 2021:

• For properties acquired before 27 March 2021, interest deductions on loans will be phased out at 25% per year over 4 years, until 31 March 2025
• For properties acquired after 27 March 2021, interest deductions will not be deductible (unless the property was acquired by an offer made on or before 23 March 2021 that could not be withdrawn before 27 March 2021)

The focus is on residential investment properties which can be used for long term accommodation. Typically, this would mean a house or an apartment, whether it is used for providing short-term or long-term accommodation, or even left vacant. It leaves out:

• The main family home
• Several types of residential property, farmland, certain Māori land, student, employee, and rest home accommodation
• Property developers, who can continue to deduct interest expenses
• Commercial property
• New build properties, which are exempt from the interest limitation rules
• Hotels, and other businesses set up to provide short-term rather than long-term accommodation
• Owner-occupiers who rent to flatmates

The proposed rules also contain allowance for interest deductions on a taxable sale of residential property, although deductions may be limited to the gain on sale.

You can read summary of the changes here.

Keep in mind that the proposals will be considered by Parliament and may change before being introduced.

What should you do?

As interest rate deductibility reduces, you may also find that rents increase to help you meet the higher costs. However, your mortgage interest payments may also go up, if (as seems likely), interest rates increase over that time.

Ideally, you should think carefully about your rental properties and whether they will still be fulfilling their role in your financial strategy. You might choose to keep them – switching from interest-only to principal-and-interest repayments to start reducing your interest costs over time. Or you could sell up and invest the proceeds somewhere else.

Talk to us about how the proposed rules affect you and the impact on your tax liabilities, so you can make smart decisions about your financial future.