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Crunch Time At The Polling Booths

Hopefully, the election will herald change that restores some basic fairness to the tax system, writes Mark Withers.

By: Mark Withers

2 October 2023

Well, finally we are here. The election is upon us, and never before has there been a political choice that will have such a profound impact on residential property investors’ fortunes as this one.

By increasing the bright-line to 10 years and removing interest deductibility from residential housing, Labour achieved their objective of making housing more affordable for first home buyers, at least as far as price was concerned. But on the interest rate front, not so much.

These twin policies, that amounted to a targeted capital gains tax on residential investors and a denial of legitimate expense deductibility, have had a profound impact on the residential property market.

Property investors have been targeted mercilessly as house price inflation, fuelled by the cheap Covid money, was wrestled back into the bottle. Would the increase in interest rates alone have been enough to curb house price inflation without the added denial of that interest’s deductibility?

We will never know, but one thing is certain: Labour has no intention of restoring deductibility of interest despite the unprecedented rise in rates, and having failed to implement a broad-based capital gains tax they have no plan to reduce the bright-line.

Wrong Equation

Investors have been absent from the market since these policies were rolled out. No-one has been able to contemplate building an investment portfolio of existing property with borrowed money when tax is levied on the gross rental income with mortgages still having to be serviced from after-tax cash flows. The equation simply does not work. Dropping these tax bombs on investors by changing rules that were fundamental to fairness within the tax system has had a massive detrimental impact and many unintended consequences.

We have seen rising rents as accommodation from the private sector dried up. Landlords have been forced to pass on the extra costs, and these have been handed to tenants who are themselves struggling. We now have a surge in development of high-intensity, low-quality new build dwellings encouraged by the new tax settings.

Bright-Line Impact

We have seen massive increases in complexity and compliance costs for anyone brave enough to attempt to navigate the tax changes. These include three separate bright-line changes and two different main home exemptions, the last of which raised the prospect of bright-line tax extending to the main home. Even the ability to undertake sensible estate planning has been undermined by bright-line impacts that can only be mitigated by applying the highly complex rollover relief provisions to normal everyday transactions.

The simple act of helping one’s children into property was impacted by bright-line as parents considered how best to assist without creating problems.

National’s Chris Luxon announced his party’s tax policy by saying, “We need a functioning private rental sector.” Right now, that sector is completely dysfunctional.

National has agreed to restore that functionality by returning the bright-line to two years, where it was set when they first introduced it, not as a quasi-capital gains tax but as a measure to strengthen the intentional speculation provisions in land tax rules.

Retroactive Move

National’s plan will see bright-line changed with retroactive effect. It will return the bright-line to two years from July 1, 2024, meaning that anyone who bought a property before July 1, 2022, will no longer be subject to bright-line. Good news. Sadly, the news is not as good as it might have been for interest deductibility. Rather than being restored in its entirety from a given point, it will be phased back in. From July 1 next year, interest deductibility will be at 50 per cent under National, but at 25 per cent under Labour. In 2025, National will lift deductibility back to 75 per cent and from July 1, 2026, deductibility will be fully restored.

Absent from National’s policy was any mention of removal of residential loss ringfencing. This means that tax losses that flow from the restoration of interest deductibility cannot be offset against income other than rent. But at least investors will not be taxed on rental incomes that, in reality, were nothing more than actual cash losses.

So, there you have it, a stark contrast between the two parties. Hopefully, the election will herald change that restores some basic fairness to the tax system and strips away the negative influence tax driven social agendas have had on tax policy.

See you on the other side.

Mark and his team specialise in advising on property-related transactions, valuation and restructure services, and tax planning. PKF Withers Tsang & Co Phone 09 376 8860, www.wt.co.nz

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