Chris Hipkins has indicated Labour won't revisit interest deductibility, but the possibility of a capital gains tax (CGT) is raising fresh questions for New Zealand property investors. We sat down with Lighthouse Financial Managing Director Matt Harris to unpack what these tax policies mean for investors, why the distinction matters, and whether property still stacks up as a long-term investment.
Why Interest Deductibility Matters for Property Investors
Interest deductibility has been one of the more controversial tax policies affecting New Zealand property investors in recent years.
At its core, the principle is relatively straightforward. If you incur an expense to generate income, that expense should generally be deductible.
Matt explains this through a simple example: if a mechanic needs to purchase oil to service a customer’s car, the cost of that oil is an expense incurred to generate income.
The same principle applies to investment property. If an investor borrows money to purchase a rental property, the interest paid on that borrowing is a cost associated with earning rental income.
However, when Labour previously removed interest deductibility for existing residential investment properties, it created some challenging financial situations for landlords.
Consider an investor receiving $30,000 in annual rental income while paying $30,000 in mortgage interest.
Without interest deductibility, the numbers could look something like this:
- Annual rental income: $30,000
- Annual mortgage interest: $30,000
- Income remaining before other expenses: $0
- Taxable income before other deductions: $30,000
- Potential tax liability: Approximately $10,000
Despite having no income left after paying mortgage interest, the investor could still face a substantial tax bill.
Matt recalls seeing this situation firsthand with Lighthouse Financial clients, some of whom were forced to sell properties or find additional funds to cover their tax obligations.
Another point of contention was the inconsistency in how the rules applied. While existing residential investment properties were affected, commercial properties and qualifying new builds were treated differently.
For Matt, this raised a fundamental question about fairness within the tax system.
Interest Deductibility vs Capital Gains Tax: Which Makes More Sense?
With Chris Hipkins signalling that Labour won’t revisit interest deductibility, attention has shifted towards the possibility of introducing a capital gains tax.
While Matt isn’t particularly enthusiastic about either approach, he believes there is an important distinction between the two.
Interest deductibility restrictions can create tax obligations even when investors have little or no cash left from their rental income. A capital gains tax, on the other hand, would generally apply when an asset is sold and a gain is realised.
In other words, investors would have proceeds from the sale to help meet their tax obligations.
“If I had to pick my poison, I would take capital gains tax all day long.”
However, that doesn’t mean Matt supports introducing another tax.
He questions whether New Zealanders are already paying enough through PAYE, GST, levies, rates and taxes on investment income.
For someone who has spent years working, saving and investing their remaining income, the prospect of another tax when they eventually sell an asset raises questions about how much taxation is appropriate.
Matt argues that the Government should also consider opportunities to reduce spending and operate more efficiently, rather than continually introducing additional taxes.
Could a Capital Gains Tax Make Property Investment Less Attractive?
One of the biggest questions surrounding a potential capital gains tax is how it could affect the financial returns available to property investors.
During the episode, the discussion turns to a hypothetical $700,000 investment property.
If that property experiences annual capital growth of approximately 4%, it could generate around $25,000 in unrealised capital gains in a year.
However, under the hypothetical 28% capital gains tax used in the discussion, the investor would retain approximately $17,000 to $18,000 of that gain after tax.
Now consider an investor who is already contributing approximately $12,000 annually to cover the property’s holding costs.
Suddenly, the margin between what they’re spending and what they’re potentially earning becomes considerably smaller.
And that’s before accounting for the risks associated with owning investment property, including:
- Unexpected maintenance and repairs
- Periods without tenants
- Changes in borrowing costs
- The financial risks associated with taking on debt
The concern is that if property investment becomes less financially attractive, some investors may choose to put their money elsewhere.
While that could potentially put downward pressure on property prices, James and Matt question what the wider consequences might be.
Private landlords provide accommodation for a significant number of New Zealanders. If fewer people are willing to invest in rental properties, there could be consequences for tenants and the Government’s ability to meet housing needs.
Falling property values could also have wider consequences for the economy. When homeowners lose equity, consumer confidence can take a hit, potentially leading to reduced spending, fewer employment opportunities and slower economic growth.
While reducing New Zealand’s reliance on property and encouraging investment in more productive assets is important, any shift needs to be gradual and carefully considered.
Would Capital Gains Tax Apply to Businesses Too?
Property investors aren’t the only people who could be affected by a potential capital gains tax.
One of Matt’s biggest concerns is whether a future policy would extend beyond residential property to include shares, commercial investments and business sales.
For many New Zealand business owners, their business represents years of hard work, financial sacrifice and personal risk.
In some cases, selling that business is also a significant part of their retirement plan.
Matt questions whether taxing the eventual sale of a business could discourage people from taking the risks required to start and grow one.
After all, business owners are often responsible for employing people, purchasing equipment, investing in growth and contributing to the wider economy.
If the financial reward for taking those risks becomes less attractive, some people may decide they’re better off working for someone else.
The concern isn’t simply about how much tax an individual might pay. It’s about how tax policy could influence investment decisions and economic activity.
What Happens to Assets You Already Own?
Another major unanswered question is how a capital gains tax would apply to assets purchased before the policy was introduced.
For example, what happens to someone who has owned an investment property for 30 years?
Would they be taxed on the entire capital gain when they eventually sell, or would the Government establish a valuation at the time the new tax takes effect?
Matt suggests that a valuation-based approach could be more reasonable, but it would also introduce considerable complexity.
Property owners might need valuations to establish the starting value of their assets, potentially creating additional work for accountants, lawyers and property valuers.
There are also questions about which valuation methods would be accepted and how disagreements over property values would be handled.
Until the details of any proposed capital gains tax are established, these questions remain unresolved.
Is Property Still Worth Investing In?
Despite the uncertainty surrounding future tax policy, Matt remains a strong advocate for long-term investing.
At Lighthouse Financial, the focus is on building wealth over time rather than making short-term decisions based on political announcements.
For Matt, property continues to offer several advantages.
1. The ability to use leverage
Property allows investors to borrow against an asset, potentially increasing the return on their initial capital. Of course, borrowing also introduces additional financial risk.
2. A tangible, familiar investment
Bricks and mortar remain a well-understood investment in New Zealand, making property an attractive option for people who prefer owning a physical asset.
3. Opportunities to add value
Unlike many passive investments, property provides opportunities for investors to actively improve an asset.
That doesn’t necessarily mean undertaking an extensive renovation.
Simple improvements such as painting, replacing carpets, updating curtains or improving the landscaping can potentially increase a property’s value.
This means investors aren’t entirely reliant on the wider market delivering capital growth.
Matt also emphasises that long-term investing isn’t limited to property. Shares and other investments can play an important role in growing wealth over time.
Should Tax Influence Your Investment Decisions?
With so much discussion about potential tax changes, it’s understandable that investors might be tempted to rethink their strategies.
But Matt believes tax shouldn’t be the primary factor determining where someone invests.
In an ideal world, tax policy wouldn’t encourage investors to choose one asset over another purely because of the tax treatment.
Instead, when assessing investments for Lighthouse Financial clients, the team focuses on three fundamental considerations:
- Capital growth: What is the investment’s potential growth over the next 10 years?
- Cash flow: How much income will the investment generate, and what will it cost to hold?
- Inflation: How might inflation affect the investment’s performance and future value?
Tax is still relevant, but it shouldn’t overshadow the underlying fundamentals of a good investment.
Ultimately, the focus should remain on making informed, long-term decisions rather than reacting to every potential policy change.
Key Takeaways
- Interest deductibility remains an important consideration for property investors. Restricting deductions can create significant tax obligations even when rental income is absorbed by mortgage interest.
- A capital gains tax would operate differently. Taxing realised gains at the point of sale could avoid some of the cash flow challenges associated with interest deductibility restrictions.
- The wider consequences matter. A capital gains tax could influence property investment returns, rental supply, business ownership and broader investment decisions.
- The details of any proposed policy will be critical. Which assets are included, how existing investments are treated and how valuations are calculated could make a substantial difference.
- Property still offers long-term investment opportunities. Leverage, potential capital growth and the ability to add value remain important considerations.
- Investment fundamentals should come first. Capital growth, cash flow and inflation should remain central to investment decisions, regardless of potential tax changes.
Next Steps:
If you’re investing in property or thinking about your next move, get in touch with the Lighthouse team to make sure you understand how the current tax rules affect your investment.
If you’d like to watch more, check out this episode below.
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.
