On 23 March 2021 the Government made an unexpected and unwelcome announcement that the bright-line rule would be extended to 10 years with near immediate effect and interest deductions on investment properties would be phased out over a 4 year period.
Brightline Rule Extension
The original bright-line period introduced on 1 October 2015 was two years and from 29 March 2018 the bright-line period has been 5 years. This means that if you purchased and sold a residential property within 5 years, regardless of intention you would be taxed on the gains, unless one of the very limited exemptions applied.
From 27 March 2021, any property purchased which does not constitute a ‘new build’ will be subject to a 10 year bright-line. Of note is, an exemption to this rule for ‘new builds’, which will continue to be subject to the 5 year bright-line period. At this stage, there is not much detail on what constitutes a ‘new build’, although it appears that it will include properties that are acquired within a year of the Code Compliance Certificate being issued.
The main home exemption will continue and inherited property will still be exempt. However, the main home exemption has been modified to account for mixed use. Currently, it’s all or nothing based on whether the property has been used as a main home for the predominant amount of time it has been owned. For properties purchased after 27 March 2021 that are used as both a main home and for investment purposes, tax will be payable on the sale based on an apportionment for the time it was used as a main home.
Removal of Interest Deductibility
Interest deductibility on any residential properties purchased after 27 March 2021 will no longer be deductible after the rules come out of consultation on 1 October 2021. Interest deductibility on existing properties will be phased out over the next four years, so from 1 April 2025 property investors will not be able to claim any interest as a deductible expense against residential rental income.
This is the more significant of the two new changes and comes without warning or industry consultation.
At this stage, the Government has signaled that interest will still be deductible in relation to ‘new build’ properties that were purchased for investment purposes. The question remains, what constitutes a ‘new build’?
The Government has now gone into a consultation period until 1 October 2021 and we expect things to become clearer following this.
The following table illustrates how interest deductions can be claimed for existing properties owned:
For dealers, developers and traders inland, interest will still be deductible on the basis that they would pay Income Tax on any profit from the sale of property under the taxation of land provisions.
What Does It Mean?
The introduction of a 10 year bright-line period when the Government promised one would not be introduced is very worrying. It is now a Capital Gains Tax in disguise and surely at this stage it would be easier for the Government to simply introduce a Capital Gains Tax and remove all the other rules implemented over the last few years to make it simpler for property investors to comply.
In addition, the 10 year time frame severely limits property investors ability to restructure their affairs to account for a change of strategy or business risk. Or sell due to personal circumstances such as family death, illness, job loss or simply a run of bad tenants.
The more serious outcome here is the removal of interest deductions against investment property income. 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. The removal of this deduction, in my view is an unacceptable targeting of property investors and creates inequality in the tax system by treating one type of taxpayer differently to another.
This will hurt leveraged investors especially, but will increase the tax burden across the board for property investors whose taxable income and economic outcomes will not match.
Further, the Government’s narrative that they are shutting a long-standing loop hole that speculators use to avoid tax is ridiculous. The majority of investors we work with are long-term buy and hold investors seeking to grow wealth over an 8 to 10 year time period and as such are hardly relying on any tax loopholes.
Both Treasury and economists predict rents will rise and it seems obvious that they will have to as investors seek to recover their costs and meet their outgoings. This will be compounded by the sale of in-situ houses to first home buyers which will diminish rental supply and drive rents up further.
In my mind the Government has made the wrong call to target the demand side, when it is clear that we have a supply issue. This is a windfall for property developers and it is clear new builds will become more attractive. However, developers will struggle to supply new houses fast enough to make a meaningful difference.
Whilst the new rules will have a short-term effect on the market, I do not think it will make a huge difference over time as the fundamentals of property investment still remain, incremental gain over time. Even if the market drops 10%, this is only to December prices. As a first home buyer, if you couldn’t afford to purchase then, you still wouldn’t be able to now.
The fact that almost no one (other than the Government) is praising this housing package not first home buyers, not investors, not economists tells you all you need to know about this announcement.
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