Know your tax: interest deductibility and the bright-line test

The basic idea behind interest deductibility is that if you own a rental property with a mortgage, you can deduct the interest you pay on that mortgage from the income you receive as rent when determining your taxable income.

In 2021, rules were put in place that meant:

• You could no longer claim a deduction for interest on your rental property if you purchased it on or after 27 March 2021 
• Your ability to claim interest deduction for rental property purchased before 27 March 2021 was being phased out.

There were some exceptions to this, such as if the property was a new-build.

Interest deductibility has been restored, which means you can now claim interest as an expense for any residential investment property you own, irrespective of when the rental property was purchased or when the loan was drawn down. The changes are happening in two phases:

• From 1 April 2024, you can claim a deduction for 80% of the interest on funds borrowed for the residential property 
• From 1 April 2025, you’ll be able to claim 100% of the interest deduction instead of 80%.

Tax calculations can be complex and affect investors differently. The savings from these tax changes may differ, as tax rules vary according to property type, date of purchase and who is renting the property.

Here are two scenarios for an investment property with:

• A $650,000 home loan with a 30-year loan term 
• A 7.24% p.a. one-year fixed interest rate 
• Principal and interest repayments. 

We’ve used the 33% income tax rate in these scenarios.

As this purchase occurred after interest deductibility was removed, it’ll be the first time the property investor can claim a tax deduction for interest costs: 

• The property investor can now get an 80% tax deduction on interest costs to offset their taxable rental income for 1 April 2024 to 31 March 2025
• This could save the property investor approximately $12,245 in tax in the first year alone – that's $235 per week.

As this purchase occurred just before the tax changes in 2021, the property investor would've been operating under a slightly different set of tax rules: 

• For the tax year ending 31 March 2024, the property investor could deduct 50% of their interest costs when calculating their tax
• For 1 April 2024 to 31 March 2025, this deduction has increased to 80%
• The property investor could save an additional amount of approximately $4,514 in the tax year ending 31 March 2025 – that’s $87 per week. 

The property investor won't save as much on tax because they weren’t paying as much tax to begin with.

The bright-line test (or bright-line rule) means if you sell a residential investment property – such as your rental – within a set time after purchasing it, you may have to pay income tax if you make a gain on the sale. There are some exceptions to this rule, such as:

• The property is your main home
• Rollover relief applies, e.g. the property is transferred under a relationship property agreement. 

Until 30 June 2024, New Zealand’s bright-line test applies to properties that were purchased on or after 27 March 2021 and sold within five years (for qualifying new builds) or within 10 years (for all other properties). If you purchased your property between 29 March 2018 and 26 March 2021, and sell it within five years, it will fall under the current bright-line test too.

From 1 July 2024, the bright-line test returns to a two-year period. This means if you sell your rental on or after 1 July 2024, you’ll be taxed on any gains you make from the sale if you’ve owned the property for two years or less.

The main home and rollover relief exclusions will still apply, but they’ll be tested slightly differently.

Your property will be considered a ‘main home’ if most of the home was used for most of the time you owned the property. ‘Most’ in this case means more than 50% (this is called a ‘predominant use’ test).

Rollover relief is getting simpler. Now, if the property is transferred between ‘associated persons’ (for example, close relatives or the beneficiaries of a trust), the bright-line test won’t apply as long as those persons have been associated for at least two years before the transfer.

If you own a residential investment property, it’s a good idea to understand the changes to interest deductibility and the bright-line test and how they might impact you. We recommend you contact your tax advisor or accountant. You’ll also find information on the Inland Revenue website.

Whether you’re buying your first investment property, looking to expand your portfolio, or wanting to manage your existing property loans, our Mobile Mortgage Managers are specifically trained to help you achieve your property investment goals. We’re happy to talk to you over the phone or in person – whatever suits you.

Plus, get up to speed on all things property investment with our free Property Unlocked webinars