The current rate of growth in value is unsustainable politically, equitably and economically, and so landlords/investors (now synonymous with “speculator”) have become the politically convenient focus.
Accordingly, the Government has brought out these two “big-guns” of increased bright-line timeframe and removing interest deductibility.
Yesterday, it announced the doubling of the bright-line test effective timeframe from five to 10 years, effective for residential properties acquired on or after March 27, 2021, where such properties are not the “main home” of the owner. It also removed deductibility of interest from loans relating to acquisition of rental properties (effective October 1 for properties acquired from March 27, and progressively applying to all other relevant properties from the 2022 tax year on a scaled basis, phasing out 100% of interest costs by 2025).
History tells us landlords exiting the market creates new problems such as raising rents due to shortages and de-intensification of occupancy.
So what is a speculator? Ultimately, it is about their intention at the time they acquired the property.
The tax system has always sought to tax anyone who has bought with the intention of resale and ensure they were always caught by the tax provisions. But how do you prove intention?
Such is quite an esoteric concept, and IRD certainly struggled to apply the provision to good effect, so the Government in 2015 introduced the bright-line test of two years.
To steal someone else’s definition, "a bright-line rule refers to a clearly defined rule or standard. It is a rule with clear interpretation and very little wiggle room. It establishes a bright-line for what the rule is saying, and what it is not saying".
In other words, the taxing of residential land transactions via a bright-line test has substituted a less clear rule (did you have intent to sell, or not?) with a simple (?) line in the sand, whereby people are simply deemed to be speculators in land if they hold the property for less than two years.
That seemed reasonable enough. Two years is a relatively short period of time, so isn’t it fair to say that if you only hold a property for less than two years, it is a reasonable assumption that you bought with an intention of resale?
But this was not perfect.
Life happens and numerous people were caught by this rule whereby they had no intention of resale but did sell due to marriage break-ups, changing towns/jobs, illness etc; but in the wider context, these minority of “bad” outcomes were considered an acceptable over-reach by Government.
Another downside of the two-year rule was the potential lock-in of properties, whereby some owners may have held them back from the market until the two years was up, diminishing market supply.
In 2018, the new Government, wanting to be seen to do something around the rising housing market, extended the bright-line to a five-year ownership period.
Critics were concerned five years was too long, as more “life happens” in five years, and more people who are not speculators, but just ordinary New Zealanders for whom circumstances have changed, would be caught as "speculators", when they are clearly not such. Even IRD policy advice to Government raised this concern.
If you accept that the bright-line test was designed to buttress the original taxing provisions around intent of resale by speculators (as was clearly stated by two governments), then every situation whereby there is collateral damage and it captures an “innocent” taxpayer, that is effectively a targeted capital gains tax.
As unfair as one could argue the housing market is for some, how is that building a fairer tax system?
And now the bright-line test is being be extended to 10 years, again, this creates a greater chance of an effective capital gains tax on innocent Kiwis who are not speculators.
Hopefully, there will be more exclusions introduced to address this outcome.
Removing interest deductibility for most landlords is a significant and unprincipled amendment to the tax system.
It is a fundamental premise in our tax system that if “revenue” is taxable, then the costs associated with deriving that revenue are tax deductible.
This is not the removal of a loophole, as has been suggested as the same principles of deductibility of interest apply to many other income-generating assets including commercial buildings, plant and machinery, shares etc.
The devil will be in the detail, but my pick is that rents will simply increase to compensate for the net risk/return equation.
Whether it will result in a mass exodus of landlords is less clear.
In my view, the bright-line test changes are tantamount to a capital gains tax by stealth that will capture a class of taxpayer that has never been caught before, including many ordinary New Zealanders who just have changes of circumstances beyond their control (e.g. illness) or if they were to sell their holiday homes for whatever reason (including intergenerational transfers outside of death).
Notably, unlike capital gains taxes overseas (which are often set at rates like 15%), this applies at taxpayers marginal tax rates of up to 39%.
I predict this will be a defining topic in the next election as unfairly affected people come out of the woodwork and demonstrate the blunt inequity of the tax consequences in many circumstances.
- Scott Mason is a senior tax partner at Findex in Dunedin.
