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Changes to the bright-line test and its implications for residential property owners.

The government announced changes to the bright-line test and mortgage interest deductions, in an attempt to dampen the booming property market.

The bright-line test changes will apply to properties acquired on or after 27 March 2021. The removal of interest deductions will have implications for new and existing investment property owners.

Increase from 5 years to 10 years under bright-line test

Under the changes, any residential property bought and sold within 10 years is subject to tax. Previously this applied to residential properties bought and sold within 5 years. Newly built properties, also known as new builds, are exempt and the 5 year rule continues to apply to those.

The government has tightened the main home exemption. The bright-line test effectively only applies to investment properties, as no tax is payable on your main home. Now with the changes, tax under the bright-line test may be apportioned where you did not occupy the main home for periods of 12 months or more.

Interest deductibility

The second change announced by the government and of greater consequence, is the removal of interest expense as a tax deduction on residential properties. Residential property investors routinely claim the interest on their mortgage as a tax deduction. This has been removed for investment properties bought after 27 March 2021 (with the rule coming into effect from October). Existing residential properties will have this tax deduction phased out over the next 4 years. It is yet to be seen whether the government will make an exemption for new builds.

Will these changes dampen the property market?

Most investors who are willing to hold their property for 5 years (as per the old rules) are most likely to hold for 10 years. Property is viewed as a long-term investment. Therefore, it will depend if the purchaser is buying for the long-term capital appreciation or the shorter-term investment returns of a rental property. For the later the costs associated with this have just increased, especially for highly leveraged investors with large mortgages.

 

Please see the attached Fact Sheet from Inland Revenue for further details.

If you require any further information on these law changes please contact our Property Team.

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