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More than six months after the government announced interest deductibility limitations for residential properties and a mere three days before these rules would come into force for residential rental properties owned prior to 27 March 2021, the government has released the new legislation in the form of a Supplementary Order Paper.
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The overarching principle behind the new rules is that it will not be possible to claim an interest deduction in respect of borrowing related to residential rental properties. For residential rental properties owned prior to 27 March 2021, the restriction will be phased in through to 2025. For residential rental properties purchased after 27 March 2021, this will take immediate effect, except for new builds, which have concessionary treatment.
Interest deductions will continue be available in full for the following types of property:
New builds will also have interest deductions available for 20 years from the date the Code of Compliance Certificate is issued.
Businesses developing land will continue to have interest deductions, with the usual rules being applicable.
Other developers (who are not in the business) will have access to interest deductions relating to land they develop, subdivide, or build on to create a new build. This will be available from the time development starts and end when the Code Compliance Certificate is issued. Once the Code Compliance Certificate is issued, then the new build exemption will apply.
A new build will be defined as a self-contained residence that receives a Code Compliance Certificate confirming the residence was added to the land on or after 27 March 2020. It will also include self-contained residences acquired off the plans that receive their Code Compliance Certificate on or after 27 March 2020 confirming it has been added to the land.
New builds will include modular and relocated homes, some conversions of existing dwellings into multiple new dwellings and conversion of commercial buildings into residential dwellings.
The new build exemption will expire 20 years after a new build receives its Code Compliance Certificate, or when the new build ceases to be on the land, whichever is earlier.
Specific rules are planned in relation to funding arrangements entered into after 27 March 2021 for pre-owned properties. Generally, this will make the interest non-deductible.
Borrowing used for other purposes (e.g., purchasing a business asset such as a vehicle) will continue to be deductible. A favourable ordering rule will be applicable where a loan was entered into prior to 27 March 2021 and it is not possible to determine which part of the loan relates to the business asset.
The government is also planning on two changes to the bright line test to provide relief to taxpayers caught under a subtlety in the main home exclusion or engaging in some restructuring.
The first change relates to the existing main home exclusion. Under the current rules, the main home exclusion does not apply where less than half the land is used for a main home; therefore, if you sell the land during the bright line period, the entire gain is taxable. Under the proposed new rule, the gain on sale would be apportioned between the area used as the main home and the area not used as the main home. This change would apply to property purchased after 27 March 2021.
The second change relates to some transfers to family trusts and for transfers to or from look-through companies and partnerships. These transfers would not be counted for the purposes of the bright-line test.
Close companies (companies with five or fewer individuals or trusts with more than 50% ownership) will be required to apply the rules regardless of whether their core business involves residential property. An exception will exist for Maori authorities or companies wholly owned by Maori authorities.
Companies which are not close companies would only need to apply the rules if their core business involves residential property. A company would be deemed to have a core business involving residential property if more than half their total assets was residential property.
Fortunately this legislation has been included as a Supplementary Order Paper to a current Tax Bill before Select Committee. This means the public will have the opportunity to have their say on this legislation.
More disappointing is that such fundamental legislation has been announced so close to its application date. Investment decisions have been made in the dark since March as no-one knew what the definition of a “new build” would be. There has been a concerning trend in recent years of governments failing to provide certainty by making announcements and then spending several months working through the details and implications of those announcements.
These rules will be complex and clearly will be difficult to apply in a number of instances, so the above commentary should not be relied on as final advice.
If you have any queries regarding these restrictions on interest deductions, or wish to make a submission, please contact your Baker Tilly Staples Rodway advisor.
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