The government announced yesterday proposed changes to tax legislation for residential property acquired on or after 27 March 2021. The proposed changes include:
- extending the bright-line test to 10 years
- allowing newly built homes to use a 5 year bright-line test
- amending the main home exclusion which would require tax to be paid on gains made for periods the property is not used as the owner’s main home
- not allowing property owners to claim interest on loans used for residential properties as an expense against their income from those properties.
These changes will impact both taxpayers purchasing residential investment property on or after 27 March 2021, and taxpayers who currently own residential investment property.
Brightline Test Changes
The bright-line test means if you sell a residential property within a set period after acquiring it you will be required to pay income tax on any profit made through the property increasing in value. The current bright-line period is 5 years.
The Government has announced it intends to extend the bright-line period to 10 years for residential property with an exception for newly built houses (new builds). The bright line test period for new builds will be 5 years.
Any residential property that has been used as the owner's main home for the entire time they owned it will continue to be exempt from any bright-line test. However where a property switches to or from being the owner's main home and the period when it is not their main home, the owner of a property will now be subject to the change-of-use rule which will require income tax to be paid on a proportion of the profit made through the property increasing in value.
Inherited properties will continue to be exempt from all bright-line tests.
The proposed changes apply to properties acquired on or after 27 March 2021. For tax purposes, property is acquired on the date a binding sale and purchase agreement is entered into (even if some standard conditions like getting finance or a building report still need to be met).
Interest deduction changes
Currently when owners of residential investment property calculate their taxable income, they can claim a deduction for interest paid on any loans that relate to the income from those properties (claimed as an expense). This reduces the tax they need to pay.
The Government has agreed to change these rules and going forward owners of residential investment properties will not be entitled to claim interest on loans used for residential properties.
For residential investment property acquired on or after 27 March 2021 interest deductions will not be allowed from 1 October 2021. This means if you acquire a residential property on or after 27 March 2021 and take a loan out to acquire it, you cannot claim interest paid on that loan as an expense against your property income from 1 October 2021 onwards. This means taxable income from the rental properties will be higher resulting in more tax payable. You can continue to claim other expenses such as the cost of insurance, rates and maintenance.
For residential investment properties acquired before 27 March 2021, you can still claim interest (for loans that already existed for that property) as an expense against your residential property income, but this amount will reduce by 25% each income year until the ability to deduct the interest is completely phased-out from the 2025–26 income year. If you have a standard March balance date, the proposed change will be phased in as follows:
If money is borrowed on or after 27 March 2021 to maintain or improve property acquired before 27 March 2021, it will be treated the same as a loan for a property acquired on or after 27 March 2021. Interest on it will not be able to be claimed as an expense from 1 October 2021.
The Government will consult on the detail of these proposals and legislation will be introduced shortly thereafter. Consultation will cover an exemption for new builds acquired as a residential investment property, and whether all people who are taxed on the sale of a property (for example under the bright-line tests) should be able to deduct their interest expense at the time of the sale.
Property developers (who pay tax on the sale of property) will not be affected by this change. They will still be able to claim interest as an expense.
Summary
The proposed changes will have an impact on clients with existing investment properties and those thinking of investing in property in the future. We will be looking at this soon and will contact those clients who are affected when more details emerge.
If you are in the process of purchasing investment property, it is important to consider the impact of these changes and how they will affect you noting that the changes come into effect from this Saturday 27 March 2021.
If you are concerned or would like more information, contact us to discuss further.
