The taxation environment for residential property in New Zealand has changed quite a bit in the last five years and is likely to continue to change.
MANAGING A RENTAL PROPERTY
Paying tax on income received
If you are renting out a rental property, you will have to pay tax on the income that you earn. There are some things that you can offset against the property income, but these are subject to change at any time.
- Rental income has to be taxed in the same year that you receive it.
- There are some expenses related to maintaining and renting out your property that you can claim for.
- There is no GST on residential rental property. However, if you own an investment apartment with a management or service agreement in place, there may be GST implications to consider.
- If you switch between renting out property and property dealing, you may be liable for tax when you sell.
Offsetting property losses against the other earned income
A feature of property investment schemes is the ability for people to be able to reduce the income tax that they pay on their earned income against their losses made on rental property.
There is currently a proposal making its way through the system to stop that ability to offset the losses against other income. We understand that you will still be able to offset losses on rental properties against gains on other rental properties you own. The philosophy behind this change is that you shouldn’t be investing in a rental property on the basis that it is going to make a loss.
This is a link to the issues paper launched on 29 March 2018: http://taxpolicy.ird.govt.nz/news/2018-03-29-issues-paper-loss-ring-fencing-rental-properties-released
Claiming expenses on your rental property (From Inland Revenue)
Expenses you can claim
Insurance and rates
You can claim the cost of insuring your rental property and the rates for the property.
You can claim the interest charged on money you've borrowed to buy your rental property. However, if you:
- borrowed part of the money for another purpose, or
- topped up the mortgage for another purpose, for example to consolidate debt or to buy the house you live in
you can only claim the interest that relates directly to the rental.
Fees and commission
You can claim fees or commission paid to agents who collect the rent, maintain your rental, or find tenants for you.
Fees paid to an accountant
You can claim the fees for:
- your accounts to be managed
- tax returns to be prepared, and
but not the costs involved in setting up your rental property.
Repair and maintenance costs
You can claim the costs for any repairs to the property or general maintenance. However, if you're doing the work yourself you can only claim for materials - not your time.
If the work is more of an improvement than a repair then you can't claim the cost as an expense. The distinction between repairs and improvements can be tricky, especially if the property is a "leaky" property.
If you're unsure whether work done on your property is repairs or maintenance we suggest you talk to a tax accountant.
Motor vehicle expenses
You can claim for motor vehicle expenses, such as running costs for travelling to inspect your property or to do repairs. There are two options for claiming motor vehicle expenses - you can either use our kilometre rates or claim a percentage of the total running costs and depreciation.
Expenses you can't claim
You can't claim deductions for capital expenses, private expenses, or expenses that do not relate to your rental.
Capital expenses are the costs of buying a capital asset or increasing its value, for example the cost of buying the property and making improvements. Private expenses are things you buy or pay for that are for your own benefit, rather than to generate rental income.
Expenses you can't deduct from your rental income in your tax return:
- the purchase price of a rental property
- the capital portion of mortgage repayments
- interest on money you borrow for any purpose other than financing a rental property
- the costs of making any additions or improvements to the property
- the costs of repairing or replacing any damaged part of the property, if the work increases the property's value
- real estate agent fees charged as part of buying or selling the property
MONEYWORKS NOTE – the bolded item [interest on money you borrow for any purpose other than financing a rental property] is very important. You have to be extremely careful to NOT use a revolving credit mortgage, and redraw for anything other than costs directly related to the rental property.
We have seen people mix up their personal accounts and rental property accounts, and draw down the mortgage to finance a trip or a new car. These funds are NOT for the purpose of generating income in relation to the rental property, therefore the interest relating to them is NOT tax deductible.
This is one of the reasons that it is really important that you have a good tax accountant working with you if you are choosing to have investment properties as part of your investment strategy.
If you live in the property
You can't claim for expenses that relate to your personal living costs. For example, if you move into your rental property after not being able to find tenants.
If you're living in a family home that was bought or transferred to a company, partnership, or trust which you own or control, you need to be very careful about claiming expenses. If in effect you're renting the property to yourself, we could view these claims as tax avoidance and you could face penalties, even prosecution.
Ordinarily, you can’t claim a deduction for legal expenses incurred in buying or selling a rental property, as these are capital expenses. However, where your total legal fees for the year are $10,000 or less, you can claim a deduction for legal expenses involved in buying a rental property. If you’re in the business of providing residential rental accommodation, you can also claim legal fees incurred in selling a rental property.
Depreciation of the value of the house
This historic tax deduction was rescinded in 2010, acknowledging the reality that although properties have wear and tear, they don’t actually depreciate in value. However, if the property was then sold for more than the book value, the depreciation had to be repaid to Inland Revenue (as the property had not actually depreciated in value).
However, depreciation of chattels (carpet, window coverings, appliances) is still tax deductible.
SELLING YOUR RENTAL PROPERTY
Bright Line Test
This was introduced at on 1st October 2015, so that anyone who purchased a property that was not their family home, and sold it within two years of that purchase, would need to pay a capital gains tax on any gains received on that value in that time period.
On March 28th 2018 this test was changed to a five year period.
There are three exclusions to the bright-line test:
- It’s your family/main home
- You inherited the property
- You're the executor or administrator of a deceased estate.
A property transferred to you under a relationship break-up isn't excluded from the bright-line test.
If you receive a property as part of a relationship settlement agreement, you won't need to pay income tax on the property when it's transferred to you.
However, if you go on to sell this property within five years of its original purchase date, the bright-line test will apply.
The Bright-line test - If the property sells at a loss
Under the bright-line test, if a residential property is sold at a loss, the loss will be "ring-fenced". This means you can subtract the "ring-fenced" loss from income you earn on a future property sale and pay less tax.
You can only offset the loss against income from a property sale. For example, you can't offset the loss against salary, wage or rental income.
Common misconception about selling property (from Inland Revenue)
If I only sell one property or hold a property for 10 years before I sell, I won't have to pay tax.
What the law says: Wrong on both counts. It always comes back to your intention when you bought the property. If one of your intentions was resale, you'll pay tax on any profit you make when you sell. It's a popular misconception that holding a property for 10 years means you avoid paying tax.
Your intention when you purchase the property
This is a core feature of the taxation system in New Zealand, what was your intention when you purchased the property, in other words ‘how are you going to make money out of the investment’.
Clearly, if you are investing in the property that is going to make a loss on an ongoing basis and using the property to reduce your tax on your other earned income, it is hard to argue that you are investing to make a profit.
Similarly, although historically, people have been able to invest in rental property and have the tenants rent (less expenses) repay the mortgage on the property, it has been many years since we have seen the numbers work out this way. For about the last 10 years, the rental income has been too low, the costs of been too high to service a mortgage (often when it is interest only payments), and certainly not enough to start repaying the principal.
One argument on border line situations is that the owner puts in regular amounts to make sure that the principal of the mortgage is repaid over time, and that they view it as compulsory savings. We can see that this could be considered as a legitimate investment strategy.
However, investing in a rental property with interest only payments on the mortgage (that is, with the principal owing never reducing) has to be a situation that raises flags within IRD. How are you going to make money on this property?
The only viable situation is if the capital value of the property increases over time, and you make a profit. Inland Revenue is very clear that investing for the purposes of making a capital gain is a taxable activity.
It's your intention when buying a property that matters
Nearly everyone buying a property will sell it at some stage. Most people will hope that their property will gain in value, and we know that an increase in value is common. However, this alone isn't enough for any profits to be taxed. In most cases you don't have to pay tax on the eventual sale of your family home. If you bought a property as a long-term rental, then you may not have to pay tax on the sale either.
However, when a property has been bought with the firm intention of resale you'll have to pay tax on any profit from the sale. The intention to sell does not need to be the main reason for buying the property - it could be one of a number of reasons for buying.
Investing in property when you are a ‘dealer, developer or builder’ OR ‘associated with a dealer, developer or builder’
This will depend on your history of buying and selling properties, and your occupation. It is vital that you get professional taxation advice if you are likely to fall into any of these categories.
The banks requirements for treatment/designation of property
In late 2015, the Reserve Bank announced that the LVR (Loan to Value ratio) for investment properties was to be reduced. This meant that banks had to make sure that any investment properties that they were lending on needed more equity to justify the loan.
While these rules may have been relaxed slightly, it is important to understand the definitions and the implications that these definitions may have for any future wider capital gains taxes on investment properties.
Will you have to pay tax on your property sale?
Inland Revenue has a property tax decision tree that you can work through to work this out. Check out http://www.ird.govt.nz/property/property-terms-and-tools/property-decision-tree/
Here is the key Inland Revenue reference page on selling investment property and tax:
For more information, here are other blog articles on this topic.