Has the bright-line property rule failed the test?

This article was current at the time of publication.

The 10-year bright-line period for residential property investments could be cancelled without raising a dollar of revenue if the National party forms the next government.

The bright-line test was originally enacted in 2017, making any gains on the disposal of residential land acquired after 1 October 2015 liable to be assessed for income tax.

An initial two-year period was extended to five years for residential land acquired after 29 March 2018.

The regime was further extended to 10 years for existing, or “old build,” property bought after 27 March 2021, although the test for newly-built properties remained at five years.

Inland Revenue Department (IRD) spokesman Rowan McArthur says that with a five-year bright-line already in place before that (for houses purchased on or after 29 March 2018), “there isn’t really anything that can be said about the 10-year bright-line until after the houses subject to it go beyond the five-years (i.e. at least March 2026).”

The tax policy National is taking into the 14 October general election includes taking the bright-line test for residential properties back to two years by July 2024, meaning properties bought before July 2022 won’t be subject to the test at sale.

No immediate effect on cashflow

Kaison Chang CPA is a director of Auckland accountants Margin Gains/Thorne Accounting, which says 90 per cent of its clients own residential investment properties.

Chang says extensions of the bright-line test announced by the current government have had no immediate effect on cash flow.

“Mortgage interest deductibility limitation has been the big driver there.”

Under current government policy, interest is not deductible for properties bought on or after 27 March 2021.

The tax deductibility of interest on older mortgages is being phased out. At present, only 50 per cent of interest is deductible, with a step down to 25 per cent in April 2024 and zero deductibility from April 2025.

National’s policy is to keep interest deductibility at 50 per cent in April 2024, raise it to 75 per cent in April 2025, and to restore 100 per cent deductibility in April 2026. 

Chang says as interest rates have increased there have been reviews of property portfolios across the client base.

“Some investors have been selling off stock and reinvesting directly into new builds. Others have a reserve of losses that they’ve been using to offset the impact of the interest deductibility rule changes – and effectively ride things out until the election before making any further investment decisions.”

For qualifying new builds bought on or after 27 March 2021, the bright-line test is reduced to five years. Chang says that over the last two years “pretty much all” of the properties bought by his firm’s clients have been new builds.

“The 27 March 2021 extension [to 10 years] relates only to ‘old builds’, and the market has been a lot more quiet on that front.

“Investors have been less proactive in old build stock, but it’s hard to say whether the bright-line extension has had much effect.”

Chang says those buying old build stock have mostly been developers, “who are going to be taxed anyway”.

Political changes afoot

In a recent article, Kelvin Davidson, Chief Property Economist at CoreLogic, says there has been a lot of focus on the possible buying implications of a shorter bright-line test from July 2024 if a National-led government is elected.

“Some investors would no doubt be tempted to make their first purchase or expand their existing portfolio by the reduced risk of having to pay capital gains tax if they needed to sell within a short horizon.”

But on the selling side, there are “likely” some investors who are struggling with cash flow at present but are holding off from selling because a large tax bill would make the situation worse, Davidson says.

“If they suddenly find themselves off the hook for that bill, some extra listings and sales could follow soon after.”

CoreLogic’s analysis concludes perceptions that restoring mortgage interest deductibility “would open the floodgates for investors to purchase again” is probably wide of the mark.

“The key point is that the biggest challenge for making the sums work on purchasing an existing property as an investment at present isn’t the lack of mortgage interest deductibility; it’s actually the large negative gap between rental yields and mortgage rates [and significant top-ups].”

Although a National victory would induce a change in mood and sentiment among property investors, Davidson doubts it would be “a game-changer”.

Westpac Senior Economist Satish Ranchhod says the bank’s view is that the number of people in the country and the supply of houses are important for determining the underlying level of demand.

Supply is key

“However, it’s financial factors like interest rates and tax policies that have a bigger impact on affordability and the prevailing level of prices.”

“The policies proposed by some of the right-of-centre parties, including the reinstatement of interest deductibility, would make residential property more attractive for investors, and would likely boost house prices,” Ranchhod says.

That was likely to add to the demand for both new and existing homes.

“However, there could potentially be a larger impact on existing home prices, as new builds were effectively exempt from the changes to interest deductibility in recent years.”