Changes to the Property Investment Rules

On 23 March the government announced policy changes to the rules governing the property market. The intention behind these new rules is to reduce access to finance for property investors in order to give more opportunities to first home buyers.

The two key changes that impact investors are the doubling of the brightline test on 27 March 2021 and the removal of the ability to offset interest paid for residential investment against your tax bill from October 1, 2021.

What is the brightline test and how is it changing?

The brightline test is the method used to determine whether income tax is paid for capital gains received upon the sale of an investment property. 

From March 2018 the brightline test was set at 5 years, meaning if a property was sold within 5 years of being bought and the property wasn’t your primary residence for at least half the period then you owed tax on the capital gains.

Now, properties bought on or after 27th March 2021 will come under the new brightline test of 10 years. While previously the requirement to pay tax was determined by whether you lived on the property for less than half the time, the new rules apportion tax for each year the property was used as an investment property. Stuff.co.nz has a good article on how the apportioning of income tax will work. 

New builds will be exempt from the brightline test changes. Income tax for new builds will be calculated by the previous 5-year brightline test.

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Removal of tax-deductible interest on residential investment properties 

Until now any interest paid for a residential investment property could be claimed as an expense on your tax return. Now,residential investment properties bought on or after 27 March 2021 will not be able to claim any interest. For properties bought before that date the ability to claim interest will be phased out over the next five tax years. For details on the phase-out see interest.co.nz.

What the changes to the property investment rules means for mortgages

As a result of the policy changes, the banks will certainly adjust how they assess the affordability of an application.

Rental income affordability calculation

Currently banks calculate affordability of an investment property by scaling the income at 70%. 

Take a property with an expected rental income of $50,000. The bank will calculate the affordability using the conservative estimate of 70% of that, so $35,000. This is to reflect that there may be periods where the property isn’t tenanted, as well as costs such as rates, insurance and maintenance.

From here on, the banks will also need to allow for the fact that rental income will be taxed without being offset by interest costs. This will likely mean calculating affordability at 45-50% instead of 70%.

Interest rate affordability calculation

Although interest rates are currently incredibly low, the banks still calculate affordability at an interest rate of around 7%. Principal repayments must be calculated for as well as interest payments.

How the numbers stack up 

Without scaling the income, a property would need about a 9% per annum return to meet the bank’s criteria. However, if the banks calculate affordability by scaling income by 50%, a property would need approximately a 18% per annum yield. For context, most Auckland rental properties earn around 3% per annum.

Ultimately the policy changes are certainly going to restrict both the number of people able to afford an investment property and the number of properties that will be suitable for purchasing as rentals.

Note: information in this article is accurate as best it can be as at 30th March 2021.  Please consult your Accountant before making any financial decisions.

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