Breaking: Reserve Bank raises rates and new property tax policy announced, should you develop new homes or hold off? A chartered accountant explains the numbers

Although this is the Reserve Bank of New Zealand's first OCR increase in seven years, the ongoing pandemic had kept the rate at its historic low of 0.25% for more than 18 months. Its most recent decision to leave the OCR unchanged was also influenced by the current Delta outbreak in New Zealand. This increase was in line with expectations, and further rises may follow towards the end of the year and early next year...

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This brings to mind yesterday's YIJU New Zealand article on the benefits investors could gain from the new property tax policy, which attracted considerable reader attention and discussion. The combination of the Reserve Bank's sudden rate increase and the new property tax policy could significantly cool the booming property market. Meanwhile, each landlord's annual tax bill could rise by thousands of New Zealand dollars. Hearing that will surely leave many people feeling unsettled! But looking back, has any tax policy change ever escaped criticism? People complained when investment properties could no longer be depreciated, continued complaining when the bright-line test was extended from two years to five, and complained again when rental loss ring-fencing was introduced...

We have also gathered a range of public reactions to the announcement of this new tax policy:

'With higher tax bills and mortgage rates continuing to rise, small and medium-sized investors like us are bound to face cash flow problems. We pay tax if we sell and tax if we keep the property. It seems our only option is short-term property trading: buy a do-up and sell it, making whatever profit we can. At least there is no loss on the tax side.'

'I expect more capital will flow into property development, and many companies that are not developers will enter the sector. Previously, we were hesitant and developed properties to rent out long term. Now the period has become ten years, development loan interest remains deductible, and we still have to pay tax if we retain properties as rentals. We might as well become professional developers!'

'It feels as though the benefits of residential development have run their course. We might be better off following New Zealand's richest person into commercial property, or making more money from commercial properties that could later be converted to residential use and subdivided!'

So does the new property tax policy, due to take effect next March, really have no merits? We urgently contacted experienced chartered accountant Tony Su to discuss the question:

Q1: Hello. What do you think is the government's motivation for these tax reforms?

The Labour government has introduced numerous property-related policies during its 4 years in office. So far, however, they do not appear to have improved the shortage of affordable housing or high house prices in New Zealand, particularly Auckland. Prices have risen too quickly in recent years. Even amid a global pandemic, Auckland's average house price has reached NZ$1,415,000, up 24% over the past year, while New Zealand's national average house price has surpassed a million New Zealand dollars.

To give first-home buyers a fairer purchasing environment while restraining house prices and maintaining supply, on 23 March this year the government proposed extending the bright-line test from 5 years to 10 years. It also amended the tax policy allowing interest on residential investment property loans to be deducted against rental income, using 27 March 2021 as the dividing date.

• For residential properties purchased before 27 March 2021, the proportion of loan interest deductible against rental income will decrease annually, as shown in the table below;
• For existing residential investment properties purchased after 27 March 2021, loan interest will no longer be deductible against rental income from 1 October 2021.
• To distinguish these properties from existing residential properties under the policy, the government also introduced a new term, 'New Build', with an exemption allowing loan interest to remain deductible against rental income. At the time, however, the government provided no specific details.

Let us trace how the new policy developed:

Following a consultation document released in June and a Q&A in July, the government released Supplementary Order Paper No. 64 on 28 September. It provided the much-anticipated definition of a 'New Build': a property issued a Code Compliance Certificate (CCC) on or after 27 March 2020, including transportable and relocated properties. The government also proposed allowing loan interest on a New Build to remain deductible against rental income for 20 years after its CCC was issued. Whether interest can now be deducted against rental income therefore also depends on whether the property's CCC was issued before or after 27 March 2020. Specifically:

• Properties issued a CCC on or after 27 March 2020: loan interest can be deducted against rental income for 20 years.
• Properties purchased before 27 March 2021 and issued a CCC before 27 March 2020: loan interest remains deductible against rental income at annually decreasing proportions, as shown in the table above.
• Properties purchased after 27 March 2021 and issued a CCC before 27 March 2020: loan interest cannot be deducted against rental income from 1 October 2021.

This series of measures is undoubtedly good policy news for developers. The incentives direct investors towards the New Build market, increasing the supply of rental properties while leaving more existing homes for first-home buyers.

 

Q2: The government is encouraging the construction of new rental homes. Will the new policy make a significant difference to landlords? Will returns differ?

If you are buying a home to live in, are a cash buyer or are a developer, this new tax policy has no fundamental effect. But if you are a long-term rental property investor, it will significantly affect your cash flow and returns. Let us assume that four men, A, B, C and D, each chose to invest in different properties when the new policy was announced.

To simplify the calculations, we assume rent, expenses, interest, tax rates and all other parameters remain unchanged. We can readily see that buying an existing home after 27 March 2021, with a CCC issued before 27 March 2020, requires the investor to inject more cash each year. Taking inflation, the higher annual repair and maintenance costs of older homes, and rising interest rates into account, buying a New Build offers some cash flow and tax advantages over the other options.

 

Q3: What tips would you give investors choosing property investments?

First, this is not yet final legislation. Parliament is considering the proposal, and its contents will change. There is still some way to go before it becomes law. Follow YIJU New Zealand's official WeChat account to keep track of further developments with me.

Looking around the world, tax policy cannot control house prices, but it can change investment preferences. For ordinary investors with tight cash flow, New Builds may be more attractive than existing homes.

Rising land and construction costs may offset the tax advantages of New Builds.

More diverse property portfolios, including existing homes on large sections, New Builds, commercial properties and farms, may become a trend, offering greater scope for tax planning. Didn't YIJU discuss the news of New Zealand's richest person accumulating substantial commercial property holdings just the day before yesterday?

More investors may consider shifting their investment focus back to their own homes, using renovations, do-ups and extensions to achieve tax-free capital gains.

The newly announced immigration policy will give around 160,000 people the right to buy property over the next few years, worsening an already severe imbalance between housing supply and demand. It looks as though our Chinese developers and builders will be even busier in the coming years!

YIJU also invites you to join the discussion. Leave a comment below sharing how the OCR increase and forthcoming tax policy will affect your future investment choices.

 

About the expert

Tony Su

Baicheng Chartered Accountants was established in 2009. Its founder, Tony Su, is a fully licensed member of Chartered Accountants Australia and New Zealand (CAANZ), CPA Australia and the UK's Association of Chartered Certified Accountants (ACCA). Tony has specialist knowledge and extensive experience in taxation, tax auditing, business planning and business advisory services.