Welcome to Cheques and Balances, this week we’re joined by Matthew Harris, director of Lighthouse Accounting to talk interest deductibility and what it means for you.
Interest deductibility, what is it?
It’s pretty well understood that if you borrow money to derive income, you can claim a deduction for the cost of borrowing that money. Interest is a cost incurred to derive income and, on that basis, investors should be able to offset this cost against the rental income earned. In March 2021, the government came out of left field and surprised all property investors with the removal of interest deductions. The intention of the Government was to fix what is clearly a supply issue by dampening demand through taxation and other measures.
Why does it matter?
Since it’s being phased out, most Kiwi investors have paid little attention to how this will affect them and haven’t considered how much of an impact this is going to have on their cashflow. Now a year later, people are starting to feel the bite, so it’s a good time to bring up a case study.
Before changes
Imagine you own a rental property, you get $700 per week in rent (we always work on 50 weeks in the year to account for vacancy), that’s going to give you an annual income of $35,000. Then you’re going to have your standard deductions like rates, property management fees, accounting fees etc. The interest is by far the biggest cost for property investors, because property investment businesses are debt funded, more so than any other business in NZ. So 3% on $900,000 is $27,000, which is the amount that you’re able to deduct from your tax liability, resulting in a net taxable profit of $2600 and a tax a bill of $858.00.
| Before Changes |
|
| Income (rent @ $700 PW for 50 weeks) |
$35,000.00 |
| Less Expenses |
|
| Rates |
$2,700.00 |
| Insurance |
$1,500.00 |
| R&M |
$1,200.00 |
| Interest Deduction ($900,000 @ 3%) |
$27,000.00 |
| Total Expenses |
$32,400.00 |
| Net Taxable Profit |
$2,600.00 |
| Tax @ 33% |
$858.00 |
| After Changes |
|
| Income (rent @ $700 PW for 50 weeks) |
$35,000.00 |
| Less Expenses |
|
| Rates |
$2,700.00 |
| Insurance |
$1,500.00 |
| R&M |
$1,200.00 |
| Interest Deduction ($900,000 @ 3%) |
$0.00 |
| Total Expenses |
$5,400.00 |
| Net Taxable Profit |
$29,600.00 |
| Tax @ 33% |
$9,768.00 |
Want Help Finding Cashflow??
After changes
Now, if you buy an existing property, you no longer have interest deductibility, if you already have an investment property, your interest deductibility is being phased out over the next 3 years. To illustrate the impact this rule will have on everyday Kiwis, let’s use the same example and assume 0% interest deductibility.
You’ve got the same amount of rent, still paying $27,000 in interest costs, your tax bill was $858.00, it will now be $8,910.00. This is a significant out-of-pocket cost for a property investor.
Now who’s paying for this? Mum and Dad investors make up the majority of the investment property housing stock in New Zealand, that Mum and Dad have a fixed income, the home mortgage, groceries, fuel and school fees still need to be paid but now they’ve got to find another $8,900.00 in their cashflow because they provided accomodation for another person or family.
What should you do?
Landlords in New Zealand have traditionally been pretty poor at treating their property portfolio like a business. We’re a soft bunch, many of which care for our tenants and will consistently undercharge rent in order to keep tenants happy. The reality of this new change, is that rents will need to increase in order to meet these new costs.
Increase the rent
This might be a good opportunity to review the market rent for your property and adjusting it accordingly. Remember you can only increase your rent once every 12 months, so make sure you’re comfortable with the new rental rate for the following year.
Move to interest-only
Now, generally speaking, with an investment property, if you have owner occupied debt, we will advise you to have your investment property debt on interest only so you can focus on paying down your owner occupied debt first. If you don’t have your rental property on interest only, now will be perfect time to switch it over, this will decrease your minimum repayments on the mortgage and increase your cashflow in the property. Now it’s important to have a plan in place for when you come off the interest-only period as you won’t be paying off the principal on your mortgage during this time. Chat to our mortgage team if you’d like further advice on this.
Rent to social housing
One exemption from this new rule is to rent your property out to social housing, this can be through Kāinga Ora or other social housing organisations. Usually they will offer guaranteed income (whether the property is tenanted or not) and the added security that your property will returned in the same state as you initially letted it out.
For a no obligation discussion to see how we can help you on the path to wealth, please contact us.
Disclaimer:
The information in this article is general information only, is provided free of charge and does not constitute professional advice. We try to keep the information up to date. However, to the fullest extent permitted by law, we disclaim all warranties, express or implied, in relation to this article – including (without limitation) warranties as to accuracy, completeness and fitness for any particular purpose. Please seek independent advice before acting on any information in this article.
